UPDATE 1-China trust firms favor developers, but under scrutiny

* Developers are trust firms' second most favored clients

* Strong demand pushes up interest rates of trust loans

* Trust firms cut back property loans recently under regulatory order (Adds comments, background)

BEIJING, July 26 (Reuters) - China's trust firms are investing hefty sums in the real estate sector, tempted by interest rates upward of 20 percent, as property developers spurned by banks turn to private financie rs.

Chinese trusts invested 207.8 billion yuan ($32.4 billion) in the real estate sector in the first half, with two-thirds of that in the second quarter, the official China Securities Journal reported on Tuesday.

That came despite repeated regulatory restrictions to channel funds into the red-hot sector amid Beijing's efforts to cool rapid home price rises.

With property developers finding it tougher to get bank financing, many are willing to pay high interest rates for a trust loan, said Jason Bedford, manager of financial advisory services at KPMG. Rates are also rising as regulators try to curb loans by trust companies to property developers.

"We used to see rates of around 12 to 15 percent a year ago (for property loans from trust firms) , but now we are not seeing anything less than 18 percent," he said.

Trust firms have invested 16.9 percent of their cumulative assets of 3.74 trillion yuan in the property industry, second only to a 28.3 percent invested in the infrastructure sector, the China Securities Journal said, citing a report issued by the official China Trust Association.

Investments in stocks, mutual funds and bonds only account for 10 percent, it said.

Trust loans' popularity has not gone unnoticed by regulators , especially the practice of banks to keep loans off their balance sheets via the use of trust companies.

The top regulators called for banks to curb their "shadow" banking in May, forcing some trust firms to scale back their loans to the real estate sector.

CCB Trus t, owned by China Construction Bank, lowered its percentage of property investments from 50 percent to 30 percent in June, and has stopped issuing new property loans, CCB Trust project manager Wei Duan told Reuters.

Instead, funds launched by trust firms are now investing in property projects by holding an equity stake, which is still allowed by regulators, Duan said.

"Before, we would issue (property) products in the form of equity that were actually still debt," he said. "Since May, we've only issued equity."

Equity financing skirts some of the regulatory restrictions on loans, which has made them increasingly popular with developers, according to a survey of China's trust firms released by KPMG on Monday .

CCB Trust is not alone.

Managers at Sino-Australian International Trust Co. and COFCO told Reuters they have also halted property loans in recent months.

For SATC, property financing used to make up 80 percent of its business, but the Shanghai-based company stopped real estate investments this year under regulatory pressur e , said Wang Haiyang, SATC's assistant general manager of the trust department.

($1 = 6.445 yuan) (Reporting by Langi Chiang, Kevin Yao and the Beijing Newsroom; Editing by Ken Wills)