Investors in Sydney are set to reap higher rents as rental supply continues to tighten, a new report has showed.

Despite a surge in first homebuyer activity, the Real Estate Institute of New South Wales (REINSW) found Sydney's vacancy rates fell by 0.5% to 1% during the month of May. REINSW said this is the lowest level they've recorded over the past 12-months.

Supply has also been tight in the outer suburbs located 25 km or more as renters sought affordable areas to rent. Vacancy rates fell by 0.4% to 1%. Middle ring suburbs remained unchanged but still tight at 1.5%.

Demand has also been strong in the Hunter region where rental vacancy rates fell by 0.2% to 1.7%. The Illawarra region saw vacancy rates fall by 0.3% to 1.6% while in Wollongong, the proportion of available properties fell by a full percent to 1.2%.

"The results are double-edged sword: great news for landlords but grim news for tenants," said REINSW president Steve Martin. "The results for Sydney and Wollongong are concerning and show that despite falls in interest rates and additional first homeowner grants, the rental market remains extremely fragile."