Central London lettings saw one of the toughest years in buy-to-let history thanks to an over supply of rental accommodation and decreased demand from corporate tenants.

Gross yield levels have dropped from 5.25% to 5% over the past year with a net yield of only 3.25%. Knight Frank anticipates that the gross yields will remain at 5%, well below the long-term average.

Despite these factors, lettings agents feel that there are grounds for cautious optimism in 2004.

New lettings from corporate tenants increased from 13% in December 2002 to 25% in 2003 while American tenants rose from just 18% in the first half of last year to 28% in the second half. Although foreign tenancy remains below the eight-year average, the statistics support agents.

Furthermore, UK tenants are taking advantage of lower rents and “trading up” to rental properties within Zone 1. Previously priced out of prime Central London, UK tenants are using the cheaper rents on offer to re-locate and enjoy easier commutes.

Knight Frank agents report particularly strong interest from UK tenants in Chelsea, South Kensington and Knightsbridge.

The lower end of the market continues to see the strongest demand levels. Tower Hill saw especially strong tenant activity over the last quarter as it offers cheaper rents than the West End yet is within walking distance of the City.

Elsewhere in the Docklands, Knight Frank’s Canary Wharf office reports a 20% increase in rental enquiries in the final quarter of 2003.

With the recent interest rate rises from the Bank of England, Knight Frank anticipates that the growth of buy-to-let investing will be constrained.

Recovery of the stock market will further encourage investors to diversify their investments. According to the Council of Mortgage Lenders, buy-to-let lending has already fallen from 31% in December 2002 to 21% in September 2003. The drop in the number of landlords should rectify the high stock supply levels, shoring up rental yields for 2004.

Fiona Sadek, Head of Residential Research for Knight Frank commented: "On an annual basis in 2003 the growth in rental levels was – 3.9%, which was a considerable improvement on –10.4% at the end of 2002. We would anticipate this upward trend in rental growth rate to continue in 2004 with a year end forecast of 2%."