The British housing market has been spared the subprime debacle that has devastated its counterpart in the U.S. But there is something else in the United Kingdom that is causing a growing amount of pain as its housing market weakens: the build-to-let business.

Over the past decade, developers have built hundreds of thousands of downtown apartments to sell to investors who would rent them out rather than live in them. But now sales of those build-to-let units are evaporating and these developers are getting hammered.

In a prime example of the pressure being faced, developer City Lofts Group PLC, which was taken private by JER Partners and Lehman Brothers Holdings Inc. last year, collapsed last week and named Ernst & Young LLP as administrators of the firm. The company had 3,500 build-to-let apartments in its pipeline in 2006.

Also last week, U.S. private-equity group TPG pulled out of a deal to take a 20% stake in U.K. mortgage lender Bradford & Bingley PLC, which specializes in buy-to-let loans to landlords, after Moody's Investors Service cut its long-term credit rating. Shares fell on Tuesday below the 55-pence price at which investors are being asked to buy into a £400 million ($791 million) rights issue. Shares closed at 34 pence, valuing the company at £204 million, down 92% from nearly £2.5 billion a year ago.

Like subprime mortgages, the buy-to-let business was born out of the easy-money era. With financing readily available, the investment exploded in popularity over the past decade because the apartments offered the promise of better returns than pension plans, stocks and other investments. Investors benefited from rising real-estate values as well as growing demand for apartments from an influx of immigrants to inner cities. In 2002, at the height of the craze, average annual yields reached double digits.

But in some markets, investors' return on a buy-to-let property has fallen below that of a standard savings account because financing has become more expensive and difficult to obtain. Also, some downtowns are suffering from overbuilding, putting a damper on rents. "There have been a number of developers who have had an overdependence on this type of buy-to-let investor," says Nick Jopling, head of U.K. residential real estate for CB Richard Ellis.

To be sure, some British rental markets are still hot, like in London, and oversupply of housing remains less of a problem in the U.K. than in the U.S. But City Lofts was overexposed in cities that have been hardest hit by overbuilding and big price declines, such as Leeds. Analysts say the default rates are rising in these cities because investors can't rent out their units at prices needed to make mortgage payments. Also some of the mortgages that investors used to finance their acquisitions have been resetting with higher interest rates.

"We believe it is payback time for years of speculation," Alastair Stewart, an analyst at investment bank Dresdner Kleinwort, said in a February housing report. Flats and maisonettes -- as opposed to detached single-family homes -- increased to 47% of all housing starts in 2006, up from 17% in 1999, according to Britain's National House-Building Council.

MORE FROM THE PROPERTY REPORT • Blueprint: Anheuser Bid Stokes Angst in St. Louis• Plots and Ploys: Metropolitan's Close Call • Beijing's Cooldown Likely to Be Short-Lived• U.K. Estate Agents Fret

Banks tightened their lending standards last summer after the subprime market triggered the beginnings of massive write-downs. That hammered sales of the buy-to-let units. "Lenders are on to the fact that [buyers] need to be injecting substantial cash equity" if they can't find a renter, notes Lucian Cook, director of residential research at Savills, a U.K. research firm. "So they have retreated from the buy-to-let market very significantly."

The buy-to-let phenomenon took off in 1996, the same year that City Lofts was founded, when the government passed a law that made it easier to buy apartment units to rent out. By 2006, the properties accounted for 11% of total mortgage lending.

City Lofts listed on the London Stock Exchange's Alternative Investment Market in 2003, and an investor partnership formed by JER Partners and Lehman took the company private by increasing to 28% its stake in the company last year. The partnership paid £12.9 million to buy out minority shareholders and invested an additional £18 million for finance and development. JER held 75% of that partnership and Lehman owns 25%. The other 72% stake in City Lofts is held by founding shareholders. Representatives for City Lofts, Ernst & Young, Lehman and JER declined to comment.

Signs of trouble for the developer emerged in April, when the company said it would redesign plans for two new developments. Last week, the company said that it had been forced to place 250 unsold apartments in receivership in six cities, including Leeds and Manchester. HBOS PLC, Britain's largest mortgage bank, appointed property services firm Allsop as the receiver for six buildings.

Allsop receiver Jon Gershinson said City Lofts represents the first such casualty for a downtown-apartment developer in the current cycle.

--Ragnhild Kjetland contributed to this article.

Write to Nick Timiraos at nick.timiraos@wsj.com

Indian Builder Provides Real Estate in Dubai

Russia’s Pik May Not Roll

Trump to Sell Atlantic City Casino