How to find hotspots in a market of ‘irrational exuberance’

“[Investors] should interpret these forecasts with caution, as they come with huge margin of error when applied to the suburb,” Dr Reeves said.

While suburb-level data is more difficult to determine, especially during a softening in the market like in Sydney and Melbourne., it is more useful with a higher chance of resulting in a “predictable” forecast.

“City-wide, there is typically insufficient data to generate a forecast that has a useful level of accuracy. Whereas, suburb house price risk levels are highly predictable with a lot of data, and with elevated levels of downside risk in house values,” Dr Reeves said.

Currently, Dr Reeves said the Australian housing market has a high level of risk, which will continue for the near future for three reasons.

“Firstly, house prices are at levels that are not justifiable based on fundamentals such as household income. Secondly, household and investor debt levels are often excessive. Finally, there has been a very high presence of speculative investors in the housing market,” he said.

Dr Reeves added that in the last few years, the Australian property market has ‘been a classic example of irrational exuberance’.

“High levels of risk were for the most part ignored, as negative returns were few and far between,” he said.

“However, in housing markets, substantial gains can quickly be followed by sharp declines. For example, some Sydney suburbs are recording declines already of more than 20 per cent.”