Residential rents are now rising across the UK, and are forecast to continue growing for at least the next two years – leading some analysts to suggest returns on buy-to-let property look attractive again. Latest figures from property agents all point towards an improving picture for landlords, as tenant demand is outstripping the number of rental properties available in the market – pushing rents up.

A record 50,480 new tenants registered for rental accommodation in the second quarter of this year – a 16 per cent rise since the start of the year – according to figures released by agents Countrywide this week. June saw the sharpest rise, with more than 18,000 new tenants registering – the highest figure in a single month since Countrywide’s records began in 2003. By contrast, the supply of rental properties has fallen 6 per cent in the past three months.

Yolande Barnes of Savills says the demand for renting will continue to grow as more people are frozen out of home ownership by a lack of credit and a dearth of housing stock. She estimates that the UK faces a total shortfall of 1.138m homes by 2016. “This shortfall is inherent in the current structure of the housing industry,” she says. “It is predicted to continue until such a time as planning and industry practices change sufficiently to counteract it.” The imbalance between demand and supply is particularly evident in London, where corporate tenants are adding to the numbers seeking high-end rental properties. Data from Savills show that prime central London rental growth is surging, with rents up 2.5 per cent in the second quarter. This takes annual growth up to 5.6 per cent, leaving rental values just 8.8 per cent off the peak of the market.  Savills is forecasting that rents will end the year 8 per cent higher than at the end of 2009, with another 7 per cent of annual growth to come in both 2011 and 2012.

The core prime rental sector, for properties worth about £1.8m on average, has been outperforming the wider market, with rental values now just 0.2 per cent off their peak. “Investors don’t generally buy into prime London residential for income,” says Barnes. “However, yields are now moving out and, as rents rise and capital values stall over the autumn and early part of next year, yields can only improve.”
Tim Hyatt, head of lettings at Knight Frank, says high-end rents have benefited from a strong bounceback in the corporate tenant sector. “A lot of people are coming back into the city,” he says. “We’ve got supply down but enquiries up – the balance is going back far more in the favour of the landlord.”

International tenants continue to be an important force, accounting for 65 per cent of Savills’ prime central London demand. According to Ludlow Thomson, a London-based lettings agent, demand for UK rental properties from people in countries hit hardest by the eurozone debt crisis – Portugal, Ireland, Greece and Spain – grew to 20 per cent of total European demand in June, compared with 12 per cent a year earlier.

But it is not just prime central London where yields are looking attractive for property investors. Analysis for FT Money by Savills shows that, while gross yields in the second quarter are currently about 4.3 per cent for prime central London property, landlords can achieve yields as high as 6.89 per cent in Liverpool.

Savills’ map of the UK shows that yields are typically lower in smaller affluent towns and cities such as Bath (4.37 per cent), Edinburgh (4.59 per cent) and Brighton & Hove (4.72 per cent), and higher in larger cities with a greater industrial past such as Manchester (6.43 per cent), Birmingham (5.68 per cent) and Newcastle (5.48 per cent).
Yield differentials are also driven by the types of property purchased, with one-bed flats providing the highest yields.
Given the constraints on mortgage finance, many buy-to-let investors are expected to be drawn to the lower-value markets where yields are higher and it is easier to cover interest repayments out of income.

However, Lucian Cook of Savills warns that these properties are likely to see much lower house price growth in the next five to 10 years. “That means total returns are likely to be higher in the equity-rich markets, such as family housing in the south of the country, even if entry costs are much higher,” he says.