Japanese investment to China will shift to service and high-end sectors including finance, retail, real and electronic equipment as its companies are readjusting their investment models in the world's second largest economy, according to a report released on Tuesday.

The annual report by Beijing-based University of International Business and Economics, said foreign direct investment to China continued to drop last year, as Japanese companies are confronting rising labor and production material costs.

The 2015 Report on Foreign Investment in China said companies in Japan have found that gaining market share in China is no longer as easy as it once was.

Sang Baichuan, director of the Institute of International Business at the UIBE, said local companies today are quite aggressive in seizing the market after acquiring various technologies through years of development and international cooperation.

The report discovered that companies from the United States and Europe, eager to diversify their investments, have looked to China's service sector, especially the service outsourcing business.

"Japan is still confronting issues such as slow demand in the global market last year, inflation, labor shortages and a long-term financial deficit," said Ma Yu, a senior researcher at the Chinese Academy of International Trade and Economic Cooperation in Beijing.

Ma said China will continue to remain a key investment area for Japan to seek new market growth this year.

The report said as a major FDI gainer and outbound investor, China urgently needs to readjust its stance when conducting international bilateral or multilateral investment treaties or agreements. This would be helpful to protect the interests of investors in both China and abroad.