BEIJING, Dec 1 (Reuters) - An investment arm of Beijing's city government is holding talks with shareholders of Phoenix Tree Holdings Ltd, known as Danke, on raising new funds to help turn around the cash-strapped Chinese property rental firm, three sources said on Tuesday.

The potential capital injection into the company follows protests by tenants, landlords and contractors in China's biggest cities, including Beijing and Shanghai, that Danke has broken lease contracts and defaulted on payments, according to state media reports.

Shares of Danke gained as much as 20% in New York in pre-market trading on Tuesday after news of the potential fund raising. They have fallen more than 70% since making their market debut in January.

"It's not a bad idea to refinance Danke on its low valuation," said one shareholder involved in the talks, who refused to be named due to the sensitivity of the matter.

"It's still one of the largest players in the sector that should bounce back once the pandemic impact fades away."

Property rental firms have suffered in the pandemic-induced market slowdown as home rents in major cities fell. Businesses have been hit hard by COVID-19, which has also led to salary cuts and lay-offs of new graduates and white-collar workers.

The potential government-led rescue of Danke reflects growing pressure for local authorities to ease mounting credit stress and social instability caused by rental firms with cashflow problems.

Beijing E-town International Investment and Development Co, a private equity firm controlled by the Beijing municipal government, is considering becoming a major investor in the latest round of financing for Danke, said two of the sources, who declined to be named.

But U.S. hedge fund Tiger Global Management, the largest Danke shareholder, has expressed no interest in joining such a consortium, which would raise at least $100 million for Danke, said a third source with direct knowledge of the matter. Tiger held a 23% stake in Danke as of the end of September, Refinitiv data showed.

The shareholders actively involved in the municipal government-led talks include Ant Group Co Ltd , which has invested more than $100 million in Danke, said the source.

The fund-raising discussions are yet to close and are subject to changes, the sources said.

Danke and Ant did not immediately reply to emailed requests for comment. Beijing municipal government didn't respond to a faxed query and calls to Beijing E-town and Tiger Global Management went unanswered out of business hours.

Danke was managing a total 415,459 flats across China as of the end of March, a 170-fold jump in a period of more than four years, according to its earnings report.

'HIGH-RISK PRACTICES'

Beijing-based Danke operates a long-term leasing business in China including in major cities such as Beijing, Shanghai, Shenzhen, Hangzhou and Wuhan.

Danke's net loss widened 51% year-on-year in the first three months to 1.2 billion yuan ($182.65 million). The company did not disclose financial results beyond the first quarter.

From early November, some landlords, who failed to receive rents from Danke in time, started to evict tenants, many of whom had borrowed to pay off the rents for 12 months to Danke.

The Ministry of Housing and Urban-Rural Development said in draft guidelines in September that it would strengthen regulation of rental firms with such "high-risk" practices of collecting large advance payments.

The company's market capitalisation stood at $638 million as of Monday. (Reporting by Zhang Yan, Cheng Leng and Ryan Woo; Editing by Jane Merriman, Alex Richardson and Susan Fenton)