Has the bubble burst for amateur landlords?

The number of homeowners who have become amateur landlords by taking advantage of the boom in buy-to-let mortgages looks set to fall after last week's interest rate rise.

Lenders predict that the hike will put the brakes on the market as increased mortgage costs eat into rental profits. The past couple of years has seen a steady rise in a new breed of landlord as working people have taken advantage of buy-to-let mortgages. Encouraged by low interest rates, they have bought properties and rented them out hoping to make a long-term investment and a nice little monthly income.

Now there are signs that the buy-to-let bubble has burst. The south-east has seen the largest increase in the number of properties coming on to the rental market. In some areas there is a glut of properties for rent and tenants can be choosy. In a competitive market scruffy one- and two-bedroom flats fall by the wayside as tenants go for smarter homes.

An over-supply of property for rent also leads to more "voids" between tenants for landlords. The mortgage still must be paid but the owners can go for weeks without a tenant. Agents Knight Frank say the supply of rental property, mostly one- and two-bedroom flats in greater London, increased by about 25% in 1999. "In many London locations private investors have been lured by the "promise" of double-digit returns across residential property held as an investment," says the agent. "This is no longer achievable as the supply of rented property has increased but rental levels have not kept pace."

But some areas are faring better. At the heart of the capital Knight Frank branches say tenants are desperate for properties to rent. And in urban areas around Britain there are now two kinds of investors in the market - the sophisticated investor and the unsophisticated landlord. Sophisticated investors have researched the market and are fully aware of all the factors that can make a dent in their profits such as maintenance costs and having to pay the mortgage for an average of eight weeks a year when the flat is empty.

The unsophisticated landlords have been lured by reports of gross yields of more than 10%. They take out the mortgage with a deposit as low as 5%. With an increase in interest rates and a couple of no-rent months they can find themselves having to top up the mortgages out of their own pockets.

John Lee, national sales manager with the Halifax, echoes this: "There is not the same large profit margin on rental income now. As a result, customers taking out a buy-to-let mortgage are changing. People are still coming in but we haven't got as many amateur landlords as we had," he says.

Instead, the bank has been lending to people who own and let up to six properties. "They're going for a standard variable rate rather than a fixed rate because they don't want to have to pay redemption charges if they want to sell," he says.

Graham Wilby, who oversees buy-to-let for the Woolwich, has also seen a change. "More and more people are building up a portfolio of properties and becoming serious landlords. Now 40% of our business in buy-to-let is repeats, arranging mortgages for existing clients."

Figures collected by the Centre for Housing Policy at the University of York show that rents have been increasing in line with inflation. But the rise in house prices means that would-be landlords are having to pay more for properties compared to what they recoup in rent. On a monthly basis, renting looks less attractive than it did, but landlords in for the long haul will reap the benefits of a capital growth in the value of the property.

Mr Wilby says returns aren't too bad. "Someone buying a £70,000 property should get a gross rent of £7,000 on that." Experts agree that the answer to the question: "Will buying-to-let make me rich?" is: "No - not yet," but if you're happy to stick with it for 10 years and ride out the bad times then you'll amass a nice little nest egg. As Mr Lee says: "More and more people are looking to the capital growth of the property and are happy for the rental to cover the mortgage and maintenance costs."

If house prices continue upwards and lenders put interest rates up in a bid to keep the lid on the economy, then buy-to-let will be a less attractive option in six months' time, says Graham Wilby. But Malcolm Harrison, spokesman for the Association of Residential Letting Agents, is optimistic. "There is greater job mobility, a higher divorce rate and many people who can afford to buy who haven't decided where to live," he says. He urges those interested to do their research carefully and take the advice of a letting agent about tenants.

The private rented sector has increased in size since the all-time low of 7% 10 years ago and now accounts for just over 11% of the housing market, he says. Overall, rental demand should continue to go up: "There'll never be a shortage of tenants for the right properties."

• Index of Private Rents and Yields, University of York 01904-433691. Association of Residential Letting Agents, www.arla.co.uk