Understanding real estate market cycles: A deep dive into property bubbles

As a property investor, you’ve almost certainly heard the phrase “real estate bubble”. Depending on how optimistic you are, you may also spend a lot of time worrying that you’re in one, or feeling stressed about how one could impact your portfolio.

The Australian property market generates intense discussion. For homeowners, investors, and the economy, a market bubble could be very disruptive. But if you’re going to make informed investment decisions, it’s crucial to understand market cycles and recognise the signs of a property bubble.

In this blog, we’ll look at what a property bubble is, how it could impact you, and what you can do to protect yourself.

What is a Real Estate Bubble?

A “real estate bubble” is a period when property prices rise rapidly to unsustainable levels relative to household income and rents. In other words, properties become significantly overvalued compared to their fundamental worth, creating a disconnect between purchase prices and the income they can generate.

Typically, bubbles are driven by speculative behaviour rather than the fundamental value of the property. Investors often buy with the expectation of short-term capital gains, often using significant leverage In Australia, the key indicators of a property bubble include:

• House prices rising significantly faster than household incomes (price-to-income ratio expansion).
• Rental yields falling below historical averages and long-term investment returns.
  
• High levels of household debt relative to GDP.
• Increased speculative buying behaviour (high investor vs. owner-occupier ratios).
• Rapid increase in mortgage applications and housing construction
  
• Relaxed lending standards and excessive credit availability.
• Public sentiment that "property prices always go up".

The trouble is if you own an asset that increases rapidly in value, you could be forgiven for thinking that you were getting the reward for your hard work and good thinking. But the result is that we don’t always realise we’re in a bubble until it’s too late. When bubbles eventually burst, prices typically fall sharply, causing significant economic impacts including negative equity, reduced consumer spending, and potential banking instability.

Historical Market Crashes in Australia

How often does the real estate market crash? While Australia hasn't experienced a catastrophic property market crash like many other countries in recent years, it has seen significant market corrections, where prices fall sharply in a short space of time. Let’s look at some examples:

1) Early 1990s: "The recession we had to have"

Australia wasn’t the only country to experience a recession in the early 1990s, in fact 17 of the 18 OECD countries did, but it was one of the hardest hit. As stock markets crashed around the world, global share prices fell by an average of 25%, but in Australia it was 40%. Unemployment reached 10.8%.

Treasurer Paul Keating called it “the recession we had to have” because the Australian economy had been overheating, with high inflation, rising wages, and speculative investment, particularly in property and finance. 

But for those with property investments it was tough. The Reserve Bank raised interest rates, it was much tougher to borrow money, and real house prices fell by 8%. It would take almost a decade to recover.

2) The Global Financial Crisis 2007-2009

When Lehman Brothers collapsed in 2008, it sparked a global financial crisis (GFC) that impacted banks around the world. Years of generous lending had seen property prices in western economies grow rapidly, before declining sharply in places like the US and the UK, where house prices fell by 18.6%.

The Aussies fared a little better than the poms. Unlike many global markets that crashed, Australian property prices showed more resilience, declining only 4% nationally due to:

1. Quick government intervention with increased First Homeowner Grants.
2. The RBA dropping interest rates from 7.25% to 3%.
3. Strong banking regulations that prevented a subprime lending crisis like that elsewhere.
4. Continued strong immigration that helped maintain housing demand.

Still, it says something about the catastrophe elsewhere that we can say “only 4%”. Ultimately, a lot of property investors were still facing a pretty serious problem and certain sub-markets were impacted worse than others.

The 2017-2019 Housing Correction 

After years of rapid growth, the Australian housing market experienced a sharp downturn, driven by tighter regulations and lending restrictions, which included: 

1. The APRA restricted the amount banks could lend on an interest-only basis.
2. Banks had to scrutinise borrowers more closely to ensure they could afford the repayments.
3. The Royal Commission into Banking Misconduct found evidence of irresponsible lending, encouraging banks to be more restrictive.

These changes disproportionately impacted investors, especially in Sydney and Melbourne where markets declined by 15-20%.

The Frequency of Market Corrections

You can never predict a housing market correction precisely, but they tend to occur in cycles. In Australia:

• Minor corrections (5-10% price drops) occur roughly every 5-7 years.
• Major corrections (10%+ drops) typically happen every 10-15 years.

Severe crashes (20%+ drops) are much rarer in the Australian market, which is one of the reasons that property can be a good investment, but you should never assume that property values will keep increasing forever. Plenty of investors and a fair number of governments around the world have been caught out that way.

Anatomy of a Real Estate Crash

We talk about corrections and bubbles and crashes, but what does that mean for you? What does a real estate crash look like in the real world of investing?

Typically, a real estate crash is characterised by:

1. Rapid Price Decline

• Property values dropping 20% or more, pushing a lot of investors into negative equity.
• A significant increase in distressed sales and foreclosures, where homeowners are forced to sell despite unfavourable circumstances.
• An extended period of negative growth in the market, discouraging investment.
• Extended market illiquidity with properties taking much longer to sell and lower auction clearance rates
• Pronounced decline in transaction volume across all price segments

2. Unfavourable Market Conditions

• Rising interest rates, increasing the price of borrowing and debt servicing
• Tighter lending conditions with stricter LVR requirements making it more hassle to arrange finance.
• Broader economic downturn, affecting employment and income security, and potentially reducing the spending power of buyers and tenants.
• Significant gap between seller expectations and buyer willingness to pay.

3. Negative Impact on Stakeholders

• Recent buyers especially, because their LTV tends to be higher, get pushed into negative equity.
• Financial institutions reduce lending.
• House builders reduce their construction levels as lower prices squeeze margins.
• Consumer confidence goes down for fear of investing in a declining asset.
• Government may need to intervene with policy measures to stabilize markets.

Protecting Your Investment

The point is that property bubbles happen and, when they do, they can have a negative impact on you as an investor. But if you prepare, watch the market, and have contingency plans, it doesn’t have to be your undoing.

If you understand market cycles, you can make better decisions. First, be considerate of timing and plan with a calm head:

• Focus on long-term holding strategies rather than short-term gains. Even with market corrections, quality properties tend to appreciate over extended timeframes.
• Avoid speculative buying at market peaks. If everyone is rushing into the market, exercise caution.
• Maintain adequate financial buffers - ideally 6-12 months of mortgage and expense coverage per property.

Then, think about how you manage your risk. Don't max out your borrowing capacity with high-risk assets. Instead consider:

• Choosing properties with strong fundamentals, with a high likelihood of maintaining demand even in difficult times.
• Maintaining conservative loan-to-value ratios (ideally below 80%) to protect against market corrections.
• Fixing loans during uncertain times (be sure to weigh the premium cost against potential interest rate movement scenarios and outlook).
• Diversifying your portfolio across property types and/or geographic markets to reduce concentration risk.

Current Market Indicators

The Australian property market in 2025 is showing compelling signs of renewed strength. February data confirms what many analysts have anticipated - we're entering a new growth phase, with the RBA's recent rate cut acting as a catalyst for market revival.

National home values rose 0.3% in February, marking the end of a brief three-month downturn and signaling what appears to be the beginning of a sustainable growth cycle. Melbourne has surprisingly emerged as the leader, recording 0.4% growth and breaking a ten-month streak of falling values. Sydney has rebounded with a 0.3% rise, halting its previous four-month downturn.

This positive momentum is further supported by robust auction clearance rates holding around 70% across major markets - a figure consistent with healthy long-term averages. Market psychology has shifted decisively, with buyer sentiment improving substantially and the return of competitive bidding scenarios.

While regulators remain concerned about weak economic growth and potential financial shocks, with APRA considering new regulations on LTV ratios, demographic tailwinds continue to provide strong market support. Since 2007, the Australian population has grown by approximately one million every two-and-three-quarter years, with higher migration further intensifying housing demand.

Supply constraints continue to underpin price growth, with new property listings tracking 4.7% lower than a year ago and total advertised supply remaining 7.9% below the five-year average. Construction challenges persist, with rising costs and consumer skepticism about new build quality limiting supply responses. Government initiatives like the Home Guarantee Scheme continue to support first-time buyers, adding further demand pressure.

The structural factors supporting the market remain firmly in place:

• Strong population growth continues to drive housing demand
• Building completions remain insufficient to address the chronic housing shortage
• Buyer confidence is returning as borrowing costs begin to decrease
• Premium markets are leading the recovery, particularly in Sydney and Melbourne

The combination of improving affordability, strong rental yields, and the prospect of further rate cuts throughout 2025 creates a compelling environment for property investment. However, regulatory uncertainties and economic headwinds suggest that prudent investors should maintain the contingency planning we've discussed throughout this article - property remains attractive, but strategic preparation for multiple scenarios remains advisable.

Solutions for Property Investors

Smart investors can navigate market cycles with this simple, three-step plan:

1. Maintain Your Financial Health

Make sure your finances can handle any shocks by building equity buffers, so that you have enough equity in your property to keep its value above your level of debt even in the event of a downturn.

At the same time, you should monitor your overall debt levels and ensure that it’s sustainable in different scenarios. If tenant demand falls, rates go up, or house prices fall, you should feel confident you can handle it. That should include contingency plans and emergency funds to cover all eventualities.

2. Select Your Properties Strategically

Focus on properties that are less vulnerable to shocks. Areas with strong fundamentals and consistent demand drivers, like popular cities, high-quality housing, or upcoming infrastructure investment, are more likely to maintain their rental and resale value in the event of a real estate crash.

3. Use Flexible Financing Options

Maintaining multiple funding sources reduces your risk of exposure to one lender or market. Planning for interest rate changes is especially important, as a change in the RBA's base rate will impact different types of borrowing in different ways.

One way to strengthen your position in the current market cycle is to use more flexible financing options like Futurerent. With Futurerent, you can access an advance on your rent of up to $100,000 per property without taking on more debt, and up to $500,000 across your entire residential portfolio. You simply share a proportion of your rental income with Futurerent for a fixed period. This approach helps maintain your debt serviceability and reduces the risk of negative equity during market adjustments.

While market indicators are currently positive, smart investors always prepare for different scenarios. By implementing these strategies, you'll be well-positioned to capitalise on opportunities in the current growth phase while maintaining the resilience to navigate any future market shifts.