Location is fundamental to any property investment. But for buy-to-let investors, it has become more important than ever as a swathe of changes are shifting the dynamics of a historically highly-profitable market.

For years, buy-to-let has been one of the most reliable investments in property and beyond. According to one report, £1,000 invested in an average buy-to-let property with a 75% loan-to-value in 1996 would have grown to £13,048 by the end of 2013, compared to £3,654 if that sum had been invested in UK commercial property over the same period.

Now, as a growing burden of tax and regulation hits the buy-to-let sector, returns have started to decline. According to a model created by Octopus, which assesses the yield on buy-to-let investments held over an eight-year period, the average annual return will be 3.18% based on an investment made at 2017 prices. And the majority of those averaged returns will only come once the property has been sold.

It is still entirely possible to get an impressive return on investment in the buy-to-let market. Increasingly, though, something that has always been true is becoming even more important: geography. Location might once have been the difference between a good buy-to-let investment and a great one. However, in today’s lower-margin market, it can be what sets a profitable investment apart from one that will actually lose money.

As part of our research into the buy-to-let market, we looked at the areas where investors are doing well, and others where, on average, they are struggling. Here are the hot and not-so-hot spots for buy-to-let.

The hot spots

Our model (looking at yields should the property be sold eight years after purchase) suggests there are some areas of the country where buy-to-let investors can expect very healthy returns. In Scotland, an average annual yield of 8.82% is expected, with strong returns also forecast in the East Midlands (8.18%%) and the West Midlands (6.47%).

Those hunting for the very best deals could also look beyond the regional picture and delve into local detail. Within London – which, as a whole, was one of the least profitable areas for buy-to-let investors according to our model – there are still areas where the market remains buoyant. In the boroughs of Barnet, Hackney and Tower Hamlets, you could expect an average-busting return in excess of 10% over an eight-year holding; while Richmond, Brent, Hammersmith & Fulham and Southwark are all expected to deliver a loss of over 10%. Which goes to show, in a changed buy-to-let market, geography can be what makes the difference between making a mint and losing your shirt.

The not-so-hot

While Scottish and Midlands investors can be optimistic about their future prospects, in other parts of the country the picture is less rosy. Investments in the North East are expected to yield an annual average of just 1.72% if the property were sold eight years after purchase, and those in Wales a barely-profitable 0.26%.

As mentioned, London is another area where buy-to-let investments are struggling as a whole. Indeed, money put into buy-to-let in the capital is expected to lose value according to our model, with an average loss of 2.46% based on the last 12 months of performance.

To give an idea of what this looks like in practice, a typical £475,000 property bought with a 70% interest-only mortgage in London would be set to lose its owner £1,250 a year for the first five years of it being let out. In fact, it would have to be sold for £590,000 eight-years later just to effectively break even with inflation – even accounting for the income over that eight-year period.

The bottom line

For buy-to-let investors, picking property is becoming a more complex business. With margins under pressure from rising taxes and growing regulation, capital growth is becoming an even more fundamental driver of investment return than it was before.

That means geography becomes all important. And while some regions are performing much better than others, it’s all in the detail. Averages tell you only about the trend; in all parts of the country, there are highly profitable investments to be had, but you really do need to know where to look.

To find out more about how the location of a property affects its potential as a buy-to-let investment, take a read of our report, Buy-to-let Britain: a divided nation.