There’s been quite a bit of speculation over whether Australia has a property market bubble - where house prices are over-inflated compared to a benchmark - and when it might burst. According to housing experts, there are at least four scenarios where this could happen.

Australia could see a property bubble burst due to:

These four scenarios focus on different tension points in Australia’s and the global economy. One scenario focuses on the balance of actions between regulators like APRA and the Reserve Bank, combined with household mortgage stress. Another envisions the affect that unemployment might have in certain areas.

Some of the factors we may see play out, such as the federal and state government trying to intervene to “fix” problems in the market, as happens in one scenario. But other factors may be out of the government’s control, for example, where a global crisis pushes up risk premiums.

All of these scenarios highlight just how complicated and interrelated the steps that lead to a property bubble burst could be.

Lending tightening, interest rate hikes and mortgage stress

Associate Professor Harry Scheule, UTS Business School

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Following concerns of the housing bubble, bank regulator APRA increases bank lending standards, it also increases the risk weight on Australian mortgages resulting in lower loan supply and higher loan costs. Banks are encouraged to reduce interest-only loans, hold a greater amount of costly capital (making home loans more expensive) and reduce the loan amounts offered to applicants due to higher future interest scenarios.

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Following increases in interest rates in the US and Europe, as those markets recover, the Australian dollar begins to decline – forcing the Reserve Bank of Australia (RBA) to increase interest rates.

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Higher interest rates lead to higher monthly repayments, as most of Australia’s home loans are adjustable. Interest only loans are the most exposed. Higher interest rates also lead to more mortgage delinquencies.

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The banks tighten bank lending standards in response to the increase in delinquencies. This further constrains interest-only borrowers seeking to refinance after the end of the interest-only terms. This means more mortgage stress, as many had expected to roll over the interest-only period indefinitely, but now they are forced to make principal repayments next to interest payments.

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The cycle between delinquencies and tightening bank lending standards continues and as a result there’s a noticeable drop in loan supply and a fall in house prices.

Underemployment and unemployment create a slow deflation

Danika Wright, Lecturer in Finance, University of Sydney

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Unemployment and underemployment - workers who want to work more but can’t - increase. As the apartment development boom dies down, and without a mining boom to replace it, construction industry workers are at high risk.

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Households with a lot of mortgage debt are forced to limit their spending, particularly on discretionary items. This in turn affects companies that employ retail workers, reducing hours and employment.

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Employment opportunities are a major component of house price amenity, in part because demand for housing is pushed higher by inbound work-related migration. So, as there are fewer jobs nearby, the amenity value of some areas decreases.

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The number of people at risk of defaulting on their mortgage increases in areas where there is a loss of employment or reduced income. In 2008, arguably the last time Sydney house prices went through a correction, the incidence of mortgage defaults and property price declines was geographically localised.

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Borrowers who have the least amount of equity in their homes (typically the least wealthy, younger and newer entrants to housing market) are the hardest hit by falling property values. They are more likely to end up “underwater” – that is, owing more than the property is now worth – and face the prospect of a distressed sale. This in turn contributes to the downward spiral in house prices.

Australia has tighter lending criteria than regulators enforced before the global financial crisis in the United States. But concerns by regulators, including APRA, over current lending practices and potentially fraudulent activities raise questions over the real quality of mortgages and the ability of borrowers to repay them.

Government intervention failure and market repair

Professors of Economics, Jason Potts and Sinclair Davidson, RMIT

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A combination of low interest rates and low growth in new housing stock drive up Australian housing prices, a situation compounded by poor policy choices by state and federal governments and high demand from foreign residential property investors.

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As a result, housing is misallocated in the Australian market, across demographic and especially age groups. This produces demographic pressures, as millennials delay leaving home, delay starting families. This leads to political pressure on governments – increases the urge to intervene.

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The federal government intervenes, blaming the secondary drivers (particularly the non-voting group: foreign investors). They increase restrictions on foreign investment in residential housing stock.

The federal government also lobbies APRA to increase rules on financial products, while promoting a scheme to subsidise and promote first home ownership.

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Because none of these previous measures from the federal government affect the primary drivers of the misallocation of housing, domestic interest rates don’t change, and state governments do not act to release new stock. As a result, housing prices continue to grow.

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Increasingly alarmed that house prices continue to rise, the federal government starts to panic, threatening ever further regulation and starts to blame the financial system. This triggers the RBA to finally act, raising interest rates.

As interest rates rise, this causes mortgage stress, resulting in default among investors with high amounts of debt, pushing these properties onto the market. These distressed sales finally cause prices to fall.

Global crisis

Timo Henckel, lecturer at the Research School of Economics and research associate at the Centre for Applied Macroeconomic Analysis, ANU

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International crisis (whether it be political, military, economic) leads to an increase in global risk premiums.

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Borrowing costs for Australian banks rise because of this and supply of global capital falls, pushing up mortgage rates in Australia.

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The most vulnerable mortgagees can no longer afford their mortgages and are forced to sell their homes.

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House prices fall which, coupled with rising interest rates, adds further distress to households’ balance sheets, leading to more selling of houses and so on.