House prices are boiling hot: Is it a bubble ready to burst?

Image of house in a bubble, burning money
Is Australia's property market in bubble territory? And what's next for house prices? (Source: Getty)

Concerns are mounting about Australia’s red-hot housing market, with experts keeping a close eye on rising debt levels and flagging an imminent decline in house prices.

Calls are growing for runaway property values to be cooled, including from the IMF and CBA chief. The Reserve Bank also indicated it is assessing a range of “tools” to address financial stability risks associated with high house prices.

Treasurer Josh Frydenberg yesterday signalled a clampdown on growing levels of household debt, and has discussed the issue with Australia’s financial regulators.

So with house prices rising for more than 12 consecutive months and hitting record highs, the question is: are we in a massive property bubble?

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What qualifies as a housing ‘bubble’?

“It is very difficult to classify the current housing market upswing as a ‘bubble’,” CoreLogic head of research Eliza Owen told Yahoo Finance.

“Bubbles are also often characterised by high levels of speculation, which isn’t as evident in the current upswing.” Real estate speculation is when buyers purchase properties when prices are low, and sell at a higher price. When thousands of people do this at once, prices are pushed up.

According to Owens, the ‘bubble’ label is often applied retrospectively. “Often bubbles cannot be identified until they pop,” she said.

On top of that, ‘bubbles’ are often associated with financial instability, she added – but that’s not what’s happening right now. “The Australian banking system has very strong capital ratios, and a decline in house prices is unlikely to destabilise this.”

So real estate ‘bubbles’ are usually driven by huge amounts of speculation – but there are actually really good reasons why house prices are rising right now.

Why are house prices skyrocketing?

First of all, interest rates are at all-time lows, making it easier for investors and homeowners to secure a mortgage.

SYDNEY, AUSTRALIA - MAY 08: Prospective buyers attend an auction of a residential property in the suburb of Strathfield on May 08, 2021 in Sydney, Australia. Property prices continue to rise across Australia with house prices up almost 27 percent compared to five years ago. Record low interest rates have also seen a surge in home loan applications in the last year. (Photo by Lisa Maree Williams/Getty Images)
Prospective buyers flock to an auction as record low interest rates see a surge in home loan applications in the last year. (Photo by Lisa Maree Williams/Getty Images)

Secondly, owner-occupier purchases remain dominant, Owens noted.

Thirdly, house prices have not inflated everywhere – the COVID-19 pandemic has triggered certain trends, like the ‘mass exodus’ to regional areas, pushing up regional house prices. But the value of homes in some inner-city areas have actually fallen, as city-dwellers leave.

“Apartments in Sydney and Melbourne have not kept pace with house price growth in the rest of the country,” Housing Industry Association chief economist Tim Reardon told Yahoo Finance.

“We will see demand shift back to apartments with the return of migration and this will ease demand in regional areas.”

Finally, mortgage default levels are quite low, with Fitch Ratings expecting loan deferrals in 2021 to be lower than they were in 2020.

“Fitch expects deferrals to be less than 1 per cent this year, assuming lockdowns are eased by end-October,” the credit ratings firm stated recently.

So while house prices are eye-wateringly high, they’re still viable.

“I don’t think it’s a bubble until it becomes unsustainable,” Equity Economics lead economist Angela Jackson told Yahoo Finance. “That depends on lending standards remaining robust, interest rates not going up substantially and unemployment remaining low.

“If any of these changes then the current level of prices would not be sustainable and we would have a bubble – but given the current monetary policy settings and general economic environment, these price rises are sustainable.”

Danger looms: Experts flag warning signs

Though house values are ‘sustainable’, it doesn’t mean they’re ‘desirable’, Jackson continued: sky-high prices have led to greater inequality and housing unaffordability.

Ray White chief economist Nerida Conisbee said a key issue was that debt levels have risen “substantially,” with the amount borrowed for housing twice the size of that from May last year.

“This debt is becoming increasingly risky. The number of people that are borrowing over six times their income has risen rapidly,” Conisbee said.

It’s not a problem now – but will be, once interest rates rise. Recent Finder data found that one in seven Australians would struggle to make their repayments of rates increased.

The RBA has indicated it is watching house prices very closely, and concerned about mounting debt.

SYDNEY, Nov. 3, 2020 -- A man walks past the Reserve Bank of Australia in Sydney, Australia, Nov. 3, 2020. The Reserve Bank of Australia RBA slashed the country's official interest rate from 0.25 percent to a fresh record low of 0.1 percent at its monthly meeting on Tuesday. (Photo by Hu Jingchen/Xinhua via Getty) (Xinhua/Hu Jingchen via Getty Images)
The Reserve Bank is watchiing house prices closely. (Xinhua/Hu Jingchen via Getty Images)

“The prospect of large declines in property prices presents significant balance sheet risks for households, businesses and lenders,” said RBA assistant governor Michele Bullock.

“Households that have borrowed a lot to purchase a home relative to their income could, in the event of a shock to their employment status or income, find they are unable to continue to service their loans,” Bullock said.

Frydenberg has backed regulators to clamp down on high debt home loans to lessen these risks.

What’s next for house prices?

Though we aren’t in bubble territory, we’ll nonetheless see house prices come down from their current highs.

“The reality is however that very soon regulators will step in and put some restrictions on finance,” said Conisbee. The purpose of this is to cut down the number of people taking on loans that are too high relative to their incomes, and also temper investor speculation, she added.

Two things will slow house price growth, she added: there will be more supply of properties on the market as lockdown restrictions ease, and that RBA winds back their quantitative easing.

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CoreLogic’s Owens added that upswings are typically followed by downswings, with the last upswing (between 2012-17) where house prices rose 40 per cent was followed by a drop of 8.4 per cent.

“The current upswing trajectory is at a slightly faster pace, and values have so far risen 18.5 per cent between September 2020 and August 2021.

“We may see a larger downturn than in the previous cycle due to a combination of affordability constraints, ongoing international border closures and a change in lending conditions,” Owens said.

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