By Harry Pontikis
Manager, MBA Financial Services

With so much debate about an Australian property bubble and its likelihood of bursting, I offer some some easy-to-spot warning signs any person can detect.

1. Rising unemployment

When the unemployment rate begins to increase significantly, this is the biggest alarm for the property market. During a recession or tough economic times, households can make cuts on non-essential spending in an effort to keep their home. If one or both income earners in a household lose their jobs, it is very difficult to maintain mortgage repayments or investment property repayments when the essentials like food, electricity and water are under financial pressure. If, on the other hand, the unemployment rate drops, people get promotions or obtain higher wages as employers battle to keep their staff. As well as having more disposable income, people have greater confidence which may motivate them to upgrade their homes or invest in their future by buying investment properties.

2. Interest rates

In the past, the RBA’s cash rate was the indicator of home loan interest rates. The banks have decoupled their rates from the cash rate in the last few years, increasing their home loan rates steadily to consumers, even though the RBA has not increased its rate to the banks for a significant period of time. If interest rates rise significantly and sharply, people will not be able to borrow to purchase new property but will also have the effect of existing home owners not being able to afford to retain their existing property; causing more properties to go for sale whilst causing property clearance rates to also fall – having the result of a glut in properties and therefore a reduction of property prices.

3. House prices

Sharp increases in house prices which are unjustified or house price increases driven only by a single factor may fall just as sharply if that factor no longer exists. An example is house prices skyrocketing due to a mining boom.

2. Affordability

Affordability is determined by the portion of pre-tax household income needed to cover the costs of owning a home. This usually hovers somewhere between 30 and 35 per cent of the household income. If prices rise significantly above this rate, then people will not be able to purchase homes, which will cause house prices to drop until people can afford them again. Falls in income will have the same effect on peoples’ ability to afford to buy homes.

4. Lending criteria

Banks relaxing their lending criteria causes non-bank lenders to do the same, leading to an influx of money into the property market by people who may not have been able to get a mortgage in ‘normal’ economic conditions. This leads to property prices being pushed upwards, often leading to a debt-fuelled property bubble. When banks tighten their lending criteria again or significantly raise interest rates, people who got into the market under the lax and cheap lending conditions will not being able to afford their mortgages, causing an influx of properties for sale under adverse conditions.

5. Delinquencies

If people start defaulting on their mortgages, credit cards and personal loans, pushing up the rate of delinquencies, then that’s an early warning sign of consumer distress which may lead to an increase of mortgagee property sales – also an early warning indicator.

6. Falling auction clearance rates

Auction clearance rates act as an indicator of the property market’s health. A sudden drop in auction clearance rates often indicates an imbalance or issue in the property market. Sydney and Melbourne clearance rates usually hover between 70 and 80 per cent as a standard benchmark.

7. Property fundamentals change

Investment properties are bought for their capital growth and income contributions. Any significant change to either of these factors will trigger issues within the property market. For example, if vacancy rates increase, landlords may drop their rental income expectations or even sell the property if they cannot afford to hang on to it. If this happens, then there will be a flood of properties on the market, causing their prices to drop due to an increase in supply. Other investors will note the drop in rental income and not be able to justify the purchase of the property exacerbating further price drops.

8. Supply outstrips demand

If more properties are built than needed, then they will languish on the market requiring price drops to tempt buyers, causing a downward spiral. An example of this could be in the future Queensland apartment market, which is expected to see an oversupply of apartments after the completion of the Commonwealth Games. This should lead to a drop in apartment prices across the Gold Coast.

The reverse is also true, where if not enough properties are built to satisfy demand, then property prices increase.

A change in government policy relating to foreign investors can also mean an influx or a decline of property buyers which will impact property prices.

In the absence of the above factors in isolation or in combination, it’s unlikely property prices will significantly or unexpectedly drop, in my opinion. I hope this article provides some insight into the sometimes opaque lending and property worlds.

This article is not specific advice as your situation has not been taken into consideration.