Real estate is traditionally seen as a good investment. The value of property generally tracks upwards, so if you buy a house or apartment, you can expect to make a profit when you sell it on a few years later. However, all bets are off during a property bubble. Strong demand pushes prices up and investors jump on the bandwagon in a bid to make a quick buck. In the short-term, everyone’s a winner, but eventually, the bubble bursts and prices come crashing back down.

A sharp price correction in the real estate market is always painful. Those who bought at the height of the bubble usually end up in negative equity with a property worth less than their mortgage debt. It is especially painful for younger buyers who have taken on a large debt to fund the purchase of a home.

Global Economic Recession

Property bubbles are dangerous because they have a knock-on effect on the general economy when the bubble finally bursts. History tells us that a housing crash precedes a recession, which was the case in 2007. Back then, the bottom fell out of the US sub-prime market, which had a disastrous ricochet effect across the global economic community. Many major financial institutions were heavily exposed to sub-prime mortgage debt and collapsed, sending the world’s financial markets into a tailspin.

Surging House Prices

It’s a sobering tale, but rapidly rising prices in the Australian real estate market are causing leading experts to conclude a property bubble is forming. Prices are rising fast and in many areas of the country, market growth is the fastest Australians have seen for 15 years. In Sydney, property prices have risen by 18.9% in 12 months. There is a similar pattern emerging in Melbourne.

There is real concern amongst economists that when the Australian housing bubble bursts – as it almost certainly will – high levels of toxic debt will plunge the Australian economy into a nightmare recession.

Is the Government Doing Enough?

Many believe that the government is not doing enough to prevent a property bubble. The Reserve Bank of Australia slashed interest rates to a record low of 1.5% last year. Because the cost of buying is currently so cheap, demand is outstripping supply in desirable areas, thus exacerbating the problem.

40% of new loans are interest-only. This means borrowers are relying on capital growth to pay off their loan capital, which is a worrying trend. Tax breaks for property investors are also fuelling demand with 15% of Australians now buy to let property investors.

The Australian economy is very closely linked to the housing market. House building has fuelled economic growth in recent years. Surging consumer confidence has pushed many people into the property investment market, but with so much wealth tied up in property, a lot of ordinary Australians are carrying a heavy debt burden.

Australia has been lucky so far. They escaped the worst fallout from the global economic recession, largely because Chinese demand for Australian natural resources remained steady. But, if interest rates fall and the economy falters, it’s not going to be pretty.