* Investors holding 80 percent of fund ask for redemption
* Santander could inject cash to help meet payments
* Analysts say could start snowball effect in other funds
* Shares close down 4 percent
(Adds detail, analyst quotes, updates share price)
By Carlos Ruano
MADRID, Feb 16 Santander (SAN.MC) said its Banif property fund, the largest of its type in Spain, could not meet an avalanche of redemptions and had asked the stock market regulator for permission to suspend payments for up to 2 years.
Clients holding 80 percent of the fund, or 2.62 billion euros ($3.3 billion), have asked to redeem their investments but the euro zone's biggest bank said the Banif Inmobiliario Fund FII lacked the cash to do so.
Although funds invested in bricks and mortar are by their nature illiquid, analysts warned the news could spark an overwhelming redemption demand by investors in other Spanish real estate funds. Spain's nine such funds have 7.25 billion euros under management.
"I've never seen a case like it," said one fund manager at Madrid brokerage Renta 4, who asked not to be named. "It could trigger a snow ball effect; that's one of the consequences when you start to hear that the biggest (fund) is doing badly".
The news is another blow to Santander's image. It had shone amid the wreckage of European banking but has taken a battering in recent months after its Optimal investment fund disclosed a 2.33 billion euro exposure to the alleged Madoff fraud.
"The fund currently lacks the necessary liquidity to meet the full payment of the said amount," Santander Real Estate said in a statement to the stock market.
Santander's property division will use 10 percent of the fund's assets -- valued at 3.41 billion euros at end-December -- to pay investors some redemptions and said if the necessary capital could not be raised through asset sales, it would inject cash itself.
If the fund did not fulfil repayment requests within two years it would wind itself up, the statement added.
Last year Spain's second-biggest bank BBVA (BBVA.MC) was faced with a similarly massive demand by clients redeeming their investments but instead opted to buy 95.6 percent of the 1.57 billion euro fund, the second biggest on the Spanish market.
ECHOES OF HEDGE SELLOFF
The sudden demand for investments to be returned had echoes of hedge fund sell offs last year.
Such property funds cannot be traded daily but have "liquidity windows" for a few of days each year, so that, rather than an orderly sell down of assets amid extreme market nervousness, investor demand for redemptions bursts like a dam.
Keefe Bruyette & Woods analyst Antonio Ramirez said the financial impact of the news was fairly insignificant, especially since even a modest cash injection from Santander would pay for a stake in assets, not a write down.
But another analyst, who asked not to be named, said a massive number of redemption requests combined with an inability to meet those requests would hurt Santander's reputation.
"For Santander, above all its damage to its image," he said.
Santander stock closed 4 percent lower at 5.49 euros after a sharper sell off in the last 30 minutes of trade. That compared to a 3 percent fall in the DJ European banking index .SX7P.
"Maybe clients will end up being convinced to keep their stake, given that it will be two years until they recoup all their investment and the cycle could change again," said Renta 4's fund manager. "However, I think this fund will disappear."
Of the funds assets, 67 percent was invested in housing -- an area particularly badly hit by Spain's property crisis -- 18 percent in offices, and 14 percent in commercial space, the fund's fourth quarter report said.
(Reporting by Tracy Rucinski, Carlos Ruano and Ben Harding; Writing by Ben Harding; Editing by Dan Lalor and Guy Dresser) ($1 = 0.7836 euro)