• Rents are falling but is London property still a good investment?
• Buy-to-let scheme a great success with huge number of new landlords thinking it's an easy way to make money
• Problem is that rents are being squeezed between falling demand and increased supply
• London is becoming even more popular from an international perspective and interest rates are falling
• Capital gains not income is the investment driver in London and prices are rising fast
• Prices are linked to stockmarket wealth, if the stockmarket is higher in five years' time, it is likely that the property market will be up too

One of the great success stories of the last two years has been the 'buy-to-let' scheme. Ten years after the introduction of tenancy laws that made the renting of residential property to individuals as opposed to companies a practical proposition, the penny dropped and financial institutions woke up to the fact that lending to rental investors was both safe and profitable. Quite why it took them so long to realise that lending 60% of the value of a property, where the interest was covered by the rent, was better than 90% to an individual whose means of paying interest was dependent on a job, is one of those universal mysteries.

The result has been a wall of money hitting the rental market as the proverbial man on the Clapham omnibus has geared up his savings and become a landlord. The investment case looks compelling. You put down £50,000, which the bank you work for so kindly gave you as a bonus. You go to its parent and borrow £200,000 to buy the gleaming development in Docklands that your bank's venture capital associate has cleverly financed. Then you let it to an employee of the European subsidiary of your bank's parent. It all has a pleasing symmetry.

All smells sweet in the financial garden as well. The developer is confident that a 10% yield is achievable, interest rates are falling and can be fixed at just over 6% on an investment property. The market is strong after the wobbles of the previous year and, for every 5% increase in the property market, the equity in the flat goes up by 25%. What can be wrong with that? The answer is nothing; except the rather important matter of the rent; which has been going down.

As we have pointed out before in these missives, rent has always been the area of disappointment. In the first instance, developers (and their agents) are not covered by the Financial Services Act. If they were, there would be a boom in prison construction in the south-east. Often, the likely rents quoted are, at best, misleading and sometimes couched as 'guaranteed' rent. These 'guaranteed' rents are for a fixed period and one doesn't have to be too sceptical to look on it as a sales ploy or a higher price by another route.

A gross yield of 10% has always been the exception rather than the rule in central London; as a general guide, the rougher the area, the higher the rent and vice versa. More importantly, gross rents have got very little to do with the paying of interest on mortgages; it is the net rent, after agents, broken loos and defaulting tenants, which pays the bank and that net rent has in the recent past equated to a net yield of about 5.5%. Perhaps we can leave the last word on this subject to Errol Flynn, 'I have always had problems reconciling my gross habits with my net income.'

What is beginning to upset the picture is that rents are falling and tenants are becoming more difficult to find. This is not too surprising if you look at what is going on in London. On the demand side there are two factors at work.

On the one hand, the city is consolidating. When UBS and Swiss Bank merged, thousands of jobs; and potential tenants disappeared. On the other, there is a price war going on in the mortgage market; it is possible to borrow discounted money which will cost you only 3.75% for the next two years. One doesn't need to have made an attempt at Fermat's Theorum to work out that a mortgage will cost you half the price of renting.

On the supply side, London is still under cranes and a large proportion of the five thousand new units (the vast majority being two-bedroom flats in Docklands or Clerkenwell), are destined for the rental market. Add these two together and you end up with a rather uncomfortable scenario for the landlord; or do you?

Allowing for consolidation in the City, you could argue that for every bank getting smaller there is an Amoco getting married to a BP, or an Anglo-American deciding that London is the happening town. You could also say that, even if rents fall by 30%, the game hasn't changed much. Why not?

Because interest costs have also fallen by 30% over the last two years and the Central London game was never about income anyway. It was and is about capital gain, with the rent being there to cover the interest on a conservatively geared investment. That still happens; and if you are buying in Kensington, for instance, where supply is static compared with Docklands, the capital appreciation game is still very much alive and well.

Contrary to rumour, size does matter. As the vast bulk of new supply is in the two-bed range, the bigger flats and houses remain scarce on the letting market when our Rental Search department (which finds property for rental rather than purchase) goes out into that market, there is always a paucity of supply. So perhaps the moral, if you can afford it, is to stay outside the range of the man on the omnibus and go in big, good and central.

Unfortunately, perception is everything, and most landlords are uncomfortable with the new reality as they tend to look at only one side of equation and see falling yields. Historically, yields in London have been higher than almost any other major city in the world which has compensated for the generally higher interest rates that the inflation-ravaged British economy has suffered under for a generation. In the brave new world of EMU, perhaps our yields, like our interest rates, are in the process of convergence; which is probably no bad thing.

So is now a good time to invest? Assuming you share our view of the best price range and location, then the answer must be that it depends on your five-year view of the stockmarket; no one should ever go near bricks and mortar on a shorter time-frame. As the London property market seems to be so umbilically linked to the stockmarket, if your view is that stocks will be higher in five years than they are now, allowing for some sickening lurches along the way, then the answer is probably yes. There is always a better time to buy, like September 1992, but if you want a blue-chip geared investment that washes its face, it is still available.

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