Fresh alert over falling margins in buy-to-let property market lowest in two years, but still gives best growth

The profit margin on buy-to-let homes has fallen to its lowest level for at least two years, according to a survey published today by one of the industry's largest lenders.

The profit margin on buy-to-let homes has fallen to its lowest level for at least two years, according to a survey published today by one of the industry's largest lenders.

Rising house purchase prices and falling rents have pushed rental yields to a new low, Paragon Mortgages said.

The survey comes a few days after Barclays Bank warned that rival lenders were "acting irrationally" by rushing into the buy-to-let market.

Under a buy-to-let deal an investor buys a home, usually with a mortgage, in order to rent it out and reap both an appreciation in the capital value and a rental income.

But rising prices have made it more and more expensive for new investors to buy into the market, leaving them more exposed to an economic shock that could trigger a crash in prices and a fall in rents.

Paragon's survey for July shows the average price of buy-to-let homes rose 1.4 per cent on the month to £119,587 or 20 per cent higher than a year ago.

Meanwhile the average rental income fell to £9,055 from £9,133 in June, a monthly fall of 0.9 per cent and an increase of just 2.4 per cent over the past year - less than the current rate of inflation.

As a result the yield slipped slightly to 7.57 per cent, the lowest reward for investors since the survey began in February last year when yields were almost 10 per cent.

John Heron, managing director of Paragon Mortgages, said the fall in the yield mainly reflected the rise in prices, which would benefit existing buy-to-let landlords.

"Tenant demand is still very strong," he said. "This comes from various types of person - students, nurses, people on state benefit, young professionals - who for a variety of reasons don't wish to or can't buy their own home."

He said landlords had responded to the demand by increasing their property portfolios but had found themselves adding fuel to post-war boost in activity among ordinary housebuyers, so pushing up prices.

Advocates of buy-to-let can point to a yield of 3.8 per cent on the London stock market - where prices have fallen 5 per cent over the last year - and 4.6 per cent on the 10-year UK gilt.

Following Barclays' outburst, Bradford & Bingley, the UK's biggest buy-to-let lender, insisted buy-to-let was a safe investment.

Mortgage arrears are much lower than in the typical market, probably because investors tend to be wealthier than the average homebuyer.

Investors who bought into the market have done very well. The average total return nationally stood at £29,105, equivalent to 29.3 per cent - little changed from the previous month's figures of 29.4 per cent.

Stuart Jennings, a senior director at the credit ratings agency Fitch Structured Finance, said although yields were falling, demand had stabilised in recent months. "We can see that first-time buyers have dried up ... they must be skipping buying and continuing to rent," he said.

But he said amateur buy-to-let investors needed to make sure their sums added up in case they suffered what is known as a "void" - when a landlord struggles to find a tenant. "Professional borrowers tend to have a portfolio ... but the amateurs might have more problems with voids," he said.