Housing bubble

A bubble is characterised by a period of fast, unsustainably high, price growth followed closely by a sharp, painful drop.

You often hear Australians talk about a housing bubble. We've had years of high house prices in many cities, especially Sydney and Melbourne. Buying a house has never been more expensive, especially as price growth has far outstripped wage growth.

No expert really thinks Australian property prices are going to suddenly collapse (a gradual decline is another story). But the idea of a housing bubble, and what would cause large drops in property prices, is well worth exploring.

How have prices changed in Australia's cities?

Looking at median property prices in Australia's biggest cities, you can see how much prices have increased. Buying a house has never been more expensive, especially as price growth has far outstripped wage growth.

The graph below shows the median home values in each of Australia's capital cities over the last 6 years.

These figures show quite significant price growth in Sydney in 2021, with the median price soaring past $1 million. Although it is worth noting that prices have started to slow in 2022. Hobart also saw huge growth.

The figures are shocking. And in fact, early in 2021, almost half the economists in Finder's RBA cash rate survey said that the growth in prices was "unsustainably high."

The data also shows times when property prices fell in several cities. In 2018, we saw prices fall in Sydney, Canberra, Brisbane, Adelaide and Perth. This was not the bursting of a bubble, but prices did fall.

This data also reminds us that every city has its own factors at play. As property investor Chris Gray told Finder back in 2015 when asked about the housing bubble, "There are so many different markets around Australia, which are all different by price and geography, so it's hard to understand one market, let alone multiple."

So is there a housing bubble?

We can see that property prices are very high. And housing affordability is terrible. But this doesn't mean we're in a bubble.

Here are some reasons why:

• Interest rates are pretty low, which means borrowing money is cheap.
• Property prices have fallen at certain points in the last decade. Unlike in a bubble, Australian property markets do experience temporary declines followed by more growth.
• Over a very long period (decades), there has always been a long-term upward trend in Australian property prices. This is bad news for buyers, but a bubble is characterised by short-term, very fast price growth.
• Australian governments and regulators are very concerned about policies that support home ownership and stable lending environments. Policy is geared towards encouraging home ownership, which in turn promotes price growth.

If you're currently struggling to buy a home, none of the above is particularly comforting. And if you're a property sceptic, it's probably not very convincing. Because the underlying sense that property prices are too damn high is really true. It is a ridiculous situation.

But that doesn't mean it's a bubble or one that's going to burst.

What could cause a housing bubble to burst?

While we might not be in a bubble, how bubbles burst is instructive for understanding what drives property prices.

We've explored this question in-depth in an article on what happens to Australian property prices in a recession.

Broadly, the data and expert opinion suggest that the following factors could cause property prices to fall significantly:

• Interest rate rises. Low interest rates drive prices up. This is because when borrowing money is cheaper, you can afford to stretch your budget further. Prices rose significantly in 2021, at a time when interest rates were at record lows.
• Lending policy. Regulators like APRA can influence the market by restricting how much lenders can lend, what type of loans they can approve and how strict lenders have to be on new applicants.
• Declining overseas migration. Australia's economy and population growth depend in part on migration from overseas. During the pandemic, when overseas travel and migration plummeted, we did see property prices fall in the inner-city apartment category. It's hard to imagine a world where migration drastically falls for a long period, but this would certainly lower demand for property prices.
• Government policy. Debate about support for first home buyers and tax incentives for investors continue to rage. In theory, if a government scrapped the Capital Gains Tax discount for investors and reduced the tax benefits of investing, this could limit investor activity, which would give more space to home buyers. But this alone probably wouldn't destroy the market.

We have seen some of these factors play out in recent history. In late 2017, lenders became much more cautious in the wake of the royal commission into financial services.

Investment and property expert Christine Williams told Finder, "Lenders became very strict and APRA came down with some very hard-hitting policy changes" as a result of the Financial Services Royal Commission. "People just couldn't borrow the money because policies were so strict."

The commission lasted until 2019, and during this time, mortgage brokers also reported the same problem. Lenders were incredibly strict on new borrowers. And while property prices didn't fall off a cliff, they certainly fell.

How do I protect myself from a property collapse?

The words "bubble" and "burst" are very stressful if you're a property owner or just about to buy. There's no need to panic, but you need to assess your situation and prepare for the worst.

• Build up equity. When prices are dropping fast, your home could be losing value. If you haven't repaid much of your mortgage principal (the amount you've borrowed), then you could be in negative equity. Try to build equity by making extra repayments on your mortgage. If you're on an interest-only loan, consider switching to a principal and interest loan. The more of your home you actually own, the better protected you are in a crash.
• Refinance. When did you last check your mortgage interest rate? Switching to a home loan with a lower rate will save you money. And you'd better switch fast. As prices fall, so does your equity (the amount of the property you own versus how much you owe the lender). This makes it harder to refinance.
• Assess your position. Is your current home big enough for your family? Will you need to upgrade soon? If your property suits your needs and you're not worried about selling or upgrading, then a housing bubble doesn't affect you all that much.
• Don't try to pick the "bottom" of the market. If you're buying a place to live, then buy a place you can afford that suits your needs. That should be your priority. Don't obsess over the bubble bursting and try to buy at the market's lowest point, which is likely to be a fruitless endeavour. Remember, you're buying a home, not an investment.