Explainer: What exactly is a housing bubble, and what does it mean for Canberra?

My friends keep talking about a “housing bubble”. Please explain what that means so I can join in the conversation without sounding like a fool.

The current hot topic is whether some of our capital cities are in the midst of a housing bubble on the brink of popping. If you believe some pundits the imminent price correction could make history. First time buyers are waiting for the housing bubble to burst to get a foot on the housing ladder. Downsizers feel they are being urged to sell before the bubble bursts. Investors are nervous their retirement plan will crumble if the bubble exists. Buyers who are looking to upsize want to play the market, aiming to sell in the boom and buy in the bust. No matter what buyer or seller category you fall under, the potential ramifications of a housing bubble will have implications for us all. Gone are the days of market talk that is focused on a boom, the attention now surrounds the heavy speculation of a bubble.

A bubble simply means an overinflation of price. In the housing market a bubble can form from an extended period of exaggerated house price growth. Like any bubble, it is not if but when the bubble will burst. Nothing lasts forever, right? If a bubble exists and pops, house prices fall to a more sustainable level, that is equal or lower than the price point at which the exponential growth first began.

For a bubble to form it requires fuel to spark an extraordinary period of growth, normally something unforeseen. Sometimes it is difficult to even pinpoint if a bubble truly exists or is even being created until prices start to correct. Pundits, me included, like to speculate when unusual events are coupled with strong house price growth.

Currently, the finger points to Melbourne and more forcefully Sydney. Canberra has also been thrown in the mix due to continued house price growth. Buyer activity has been ignited following an extended period of historically low interest rates. It is the influence of monetary policy that has encouraged consumers to buy dwellings either as an investment or as owner-occupiers. This increase in demand has resulted in prices growing well above average.

Tighter lending conditions have been in place to help contain any potential risks within the housing market. Despite this, investor activity still poses a significant risk as prices continue to rise suggesting a possible bubble in Sydney and Melbourne. A price correction could ensue if activity becomes dampened by an aggressive rise to rates. If a heavy price correction follows, it will prove a bubble did exist.

It is highly unlikely to affect Canberra house prices. Canberra did react to the tightening of fiscal policy but this phase has truly passed. Our market has revived following a few years of sideways growth but rising house prices looks set to stay.

In reality, small towns are more susceptible to housing bubbles, in particular towns affected by an unexpected market driver. A prime example would be mining towns that experienced a boom and subsequent bubble pop once the mining phase passed. Canberra’s housing market is driven by a variety of factors that make the chance of market collapse less risky.

Nicola Powell is a property expert for Allhomes. Twitter: @DocNicolaPowell