EXPLAINER: In your 30s and want to buy a house? This is what you need to know and do.

Amid sky rocketing house prices in Sydney and Melbourne, record low interest rates, and a tax system that works in favour of investors – those who entered the housing market at the right time are reaping the benefits.

But after 25 years of unprecedented economic growth in Australia, are we still in a boom or are we blinded by a state of euphoria?

House prices have become prohibitively high in our major capital cities, making the dream of home ownership increasingly out of reach, especially for the young.

Figures in the recent Household, Income and Labour Dynamics in Australia (HILDA) survey revealed a steep drop in home ownership amongst people under 40 from almost 36 per cent in 2001 to just 25 per cent in 2015.

Dr Greg Schwann, Associate Professor of Finance at the University of Melbourne and an expert in housing and mortgages, says many crucial factors have led to the prohibitively high prices that are now locking out first home buyers.

“Australian cities are growing rapidly, more than any other cities in the world,” says Dr Schwann.

“Combine that with historically low interest rates, a growth in incomes, and immigration flows from rural and regional areas – and you have a huge boost in demand for dwellings in capital cities.”

Australia’s “bricks and mortar fixation”

Dr Schwann says the demand for housing is exacerbated by Australia’s “bricks and mortar fixation”.

“It’s the cultural idea around owning a home – which the Australian taxation system incentivises,” he explains. These tax incentives include negative gearing and capital gains tax concessions.

“You also have investors pushing up the market – baby boomers buying second houses as investment properties when they could be investing in different asset classes.”

On the demand side, says Dr Schwann, supply constraints are not helping, particularly in Melbourne. Affordability is also reduced by the preference of Australian for large houses. “We are building the largest new houses in the world”.

Paying "more than we should"?

Another crucial factor, says Dr Schwann, is the shift from one-earner to two-earner families in the last couple of decades. Instead of making houses more affordable, the ability of double income couples to pay up has just contributed to the general rise in price.

Finally, the fact that prices have been going up for so long makes people confident that prices are going to continue to appreciate. That makes them prepared to pay more now in the expectation that the value of their house will continue to rise.

“That expectation effect is enormous – it multiplies the value of houses.”

Dr Schwann is hesitant to call the current scenario a ‘housing bubble’, but says there is undeniably “some degree of bubbleness”, as people pay “more than they should” for their homes.

Headed for a 'Minsky moment'?

Melbourne University Economist Dr Matthew Greenwood-Nimmo sees some alarming parallels between the Australian housing market and the evolution of asset prices in the run-up to the Global Financial Crisis of 2008, which was a famous example of a so-called “Minsky moment”.

A ‘Minsky moment’ is named after the Polish economist Hyman Minsky, whose work focused on boom-times and the transition from boom to crash.

Although his work didn’t gain much traction in his lifetime – he died in 1996 – the relevance of Minsky’s work became widely acknowledged in the wake of the financial crisis.

“An easy way to envisage a Minsky moment is to think of a timeline,” says Dr Greenwood-Nimmo.

“To illustrate the idea, let’s start when the economy comes out of a recession. After a recession growth is generally quite quick and there are lots of profit opportunities if you’re a lender. You can make a lot of money and there’s not a lot of risk because the economy is growing fast.

“If that boom phase continues for a long time, people get complacent. It’s this complacency that can turn into a Minsky moment.”

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What happens when we get complacent

As a rule of thumb, business cycles from boom to bust usually last about six to eight years. However, Australia has now gone 25 years without a recession.

According to Dr Greenwood-Nimmo, there is a risk that complacency may have set in and may be colouring Australians’ investment decisions.

“After 25 years of growth, it could be that a euphoric sentiment has taken hold in the housing market”, he warns. “The good times have been going on so long, people start thinking they will go on forever.

“In a euphoric market, safety margins get eroded. By that, I mean that banks become increasingly willing to make large loans based on small deposits and borrowers become increasingly willing to take on a large debt burden. As long as house prices continue to rise, this strategy can work but it only takes a small shock to put you underwater on your mortgage”.

“A Minsky moment occurs when the euphoria ends, prices slump and those euphoric investors suddenly realise that they’re high and dry. The greater the proportion of investors that were swept up in the euphoria, the worse the overall outcome for the economy at large.”

Dr Greenwood-Nimmo goes on to say that the Reserve Bank of Australia has warned a few times about risks in the housing market.

“They’re reluctant to state that there may be a bubble per se, but they’re giving hints that they think that house prices in key markets – including Melbourne and Sydney – are over-valued.

“Given how conservative most central bank communications are, for the RBA to acknowledge that the housing market is showing such signs of frothiness is actually quite a strong signal that they believe that house prices may be too high relative to their fundamental level.”

A cooling rather than a Minsky moment?

The best way to avoid a Minsky moment is for the housing market to cool without crashing, says Dr Greenwood-Nimmo.

“If prices were to plateau for a bit, that would be a reasonably good outcome.”

“I think that the likelihood of a cooling off is quite high because lots of media attention has been paid to the housing market and most people are aware that housing prices in capital cities are quite high – that should act to constrain buyers’ willingness to pay.

“Nonetheless, policymakers at the Reserve Bank will face many tough choices about the best way to manage the housing market moving forward. In particular, should the RBA wish to raise interest rates to cool the housing market, it will have to act judiciously to avoid accidentally precipitating a collapse in the process.”

Interest rate rise 'inevitable'

Dr Schwann similarly isn’t anticipating a crash. He says interest rate rises are “inevitable” and that should lead to a cooling-off in the housing market.

He also says young people looking to buy a home should not to be put off by the current market.

“My advice to people between 20 and 30 is to take what money you would have spent on buying a house, and instead buy a property you can afford but don’t intend to live in.

“Rent where you want to live, and generate an income stream from the property you’ve bought. Then as your career progresses and you earn more, you can cash out the property and buy the place you want to live in.”

He says the current high prices also suggest that new home buyers need to adjust their expectations.

“Previous generations of people bought smaller places and then upgraded as they got older, and as their families grew. Now people want it all from day one.

“If first-time home owners lowered their expectations about the size of their new home, this could ease pressure on the market.”

For current homeowners Dr Schwann says there is also no need to panic about not paying off your mortgage.

“Five years after you’ve bought your property you’ll be earning more, with your career advancements, and then you won’t be stressed about paying your mortgage.

“Over time, barring divorce, paying your mortgage will become easier.”

This article was first published on Pursuit. Read the original article.

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