A housing/property bubble occurs when there is price growth (above-average growth in property prices) and mortgage related debt growth due to rapid increase in property valuations driven by demand and speculation until they reach a level that is unmanageable relative to income and rental earnings. However, eventually, property prices shift downward driven by oversupply of property, elevated levels of unemployment, government regulations and change in fiscal policies.
 
Continued low interest rates and inappropriate fiscal policies to cause bubbles
Usually, demand for home loans and housing credit growth is high during an attractive low interest rate environment, which encourages investors to borrow and invest in the real estate market. However, interest rate driven demand for properties can be diminished by central banks policy rates, such as an interest rate increase as it forces owners/developers to pay high interest payments on housing loans and leads to loan defaults/liquidity problems in the system.
 
Australian residential property market’s historical trends
Housing market turnover (transactions in the housing market involving the transfer of ownership) were seen on an uptrend during the late 1990s and early 2000s at the back of disinflation and financial deregulation that led to a rise in households’ borrowing capacity. The rate of housing turnover then trended lower since the early 2000 and the recent decline in the turnover rate has been infrequent, particularly given the strength in other indicators of national housing market activity, such as housing prices. Sizable portion of housing transactions are financed by debt; hence the value of housing turnover is closely related to the value of housing loan approvals and subsequently housing credit growth and financial markets.
 
Apartment turnover rate declining despite increasing building approvals
The national housing turnover rate has witnessed a downturn in recent years despite strength in a few housing market indicators such as national housing price growth.
 

Approvals and Apartment Turnover Rate (Sources: Australian Bureau of Statistics (ABS); Reserve Bank of Australia (RBA))
 
As per February 2017 data, the number of dwellings approved have risen 0.8%, in trend terms, after falling for eight months (data released by the Australian Bureau of Statistics). On the other hand, the value of total building approved fell 0.1% in February, in trend terms, and has fallen for seven months. The value of residential building approved rose 1.5% while non-residential building fell 3.3%.
 
Contemporary trends in property prices in Australia
According to industry reports, Australia’s capital city residential property values have been on the rise over the past three years, following a 7.4% drop over the last 1.5 year.Sydney and Melbourne have consistently showcased the strongest growth conditions of all capital cities over the past two growth cycles.
 
The overall growth for capital cities has been fueled by Sydney and Melbourne which have recorded higher growth rates compared its counterparts. Australian House Price Index measures weighted average of price movements for residential properties for eight capital cities in Australia. During Q4 (Dec-2016 quarter), residential property prices in Australia jumped 4.1% quarter on quarter (qoq), following a 1.5% gain in the Q3 and beating market consensus of a 2.4% rise. It was the fastest increase since the June quarter 2015, as prices went up in most cities: Melbourne (5.3% from 1.7% in the prior quarter), Sydney (5.2% from 2.6%), Hobart (4.5% from 2.3%), Canberra (2.8% from 0.8%), Brisbane (2.2% from 0.2%), Adelaide (1.8% from 0.9%) and Perth (0.3% from -1.6%). In contrast, prices fell in Darwin (-1.5% from -1.2%). On a yearly basis, overall house prices grew by 7.7% compared to a 3.5% rise in the previous quarter.
 
Australian housing scenario: Low interest rates and volatile markets
Australia is still characterized by housing markets in which underlying demand is more than supply, but that is expected to change over the next few years as supply increases more significantly given the current level of building approvals and constructions. Currently, there’s not too much stock on the market, there’s an oversupply in some areas and an undersupply in others.  There’s a lot of talk about Brisbane having a massive oversupply of brand new units coming on the market, but these are very volatile markets generally bought by speculators and so one change in the economy or a foreign investment review could dramatically affect those markets.
 
The Reserve Bank of Australia slashed the official cost of borrowing to 2.0% in May-2016 and came up with a further cut of 25bps in August last year to 1.5% and it has kept rates on hold for the seventh straight meeting. Although interest rates have contributed to property price growth in Sydney and Melbourne, other capital cities who have enjoyed these same rates have not recorded the same price growth trends. It’s therefore important to realize that local markets are characterized by the strength of the economy which impacts consumer confidence, borrowing power, unemployment as well as supply and demand.
 
Mortgage stress elevates if interest rates rise
Many investors are concerned about what will happen to homeowners and investors when interest rates rise if borrowers take on additional debt in a record-low interest rate environment. We believe that future interest rate hikes can affect homeowners and investors and the that will cause some mortgage stress.
 
Better to Stay Cautious
It is understood that if property prices continue to stay at outrageous elevated levels, then there may be a price correction after looking at many economic factors. Contemporary trends so far have indicated that not only demand is high, but there’s a shortage of supply as well. In such scenarios, many government bodies/ regulators also try to pitch in to balance out. For instance, APRA in an attempt to improve the conditions is now asking the banks to reduce the ‘interest-only’ loans to 30% of total lending from the current level of 40%. This is expected to limit the flow of new interest-only lending of total new residential mortgage lending. Limits have been set for the volume of ‘interest-only’ lending at loan-to-value ratios above 80% and a scrutiny of lending at loan-to-value ratios above 90% is asked for.Given the prevailing scenario, the housing market is expected to be one of the points of discussion during the upcoming RBA meeting to further analyse the situation.

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