The devil of an asset bubble is that it feeds on itself. A positive news loop encourages irrational behaviour. A combination of greed (or even worse, the ungodly sight of one’s friends getting richer without having to do any work) causes otherwise rational players to make decisions that, in hindsight, appear completely ludicrous. It appears that residential property prices in several Australian capital cities are encountering such bubble-type behaviour — none more so than sunny Melbourne, which in the December quarter of 2009 recorded house price growth of 15%. According to the Real Estate Institute of Victoria, Melbourne house prices rose by $70,000 in the last three months of 2009 — the highest since records begun in 1992.

The dot.com bubble was another perfect example of all rational behaviour being cast aside as “investors” feverishly bought stakes in very expensive companies, which made no money, were burning through their limited cash reserves and had questionable management. It didn’t take long before those technology companies ran out of cash and investors lost a fortune. The technology company bell-weather, the NASDAQ index in the United States dropped from 5132 in March 2000 to 1253 three years later (even now, a decade on, it is just over 2200).

The Japanese property bubble was similarly exuberant, but because of the nature of property, a slower moving beast. Land prices in Japan rose by more than 127% between 1979 and 1989. Since then, in 20 years, prices have fallen by 57% (the price drop was far more pronounced in Japan’s largest cities, which had experienced a far greater boom). Those who claim “property prices always go up” clearly never bought Tokyo real estate in 1990. The US property bubble exhibited similar characteristics, traditional rising in line with inflation until 1997, before virtually doubling (in real terms) between 1997 and 2007 (the nominal rise was far higher).

While exhibiting similar tendencies, compared with share bubbles, the property variety tend to take far longer to burst. There are several reasons for this. First, property buyers have less real-time market information than the share market. Share prices are often highly fluid and will react fairly quickly to market or company specific information (property by contrast is far less transparent, and data more difficult to obtain). Shares are also very easy to trade, and the transaction costs are minimal (by contrast transaction costs for property are substantial, and can often run to 5-10% of the purchase price).

A second reason for stock market bubbles bursting more rapidly than real property bubbles is the way leverage is used and the ability for lenders to “margin call” a borrower. During the recent share boom many investors were highly leveraged using margin loans or contracts-for-difference. Margin lenders will require a specific level of equity in the borrower’s account — as soon as that level is breached, the borrower will be legally required to top-up their accounts. Failure to do so will result in the lender liquidating the collateral (being the shares themselves) to cover the loan value. This occurred in many instances in 2008 and 2009 even for directors and founders of large companies such as Allco, Babc-ck & Brown, ABC Learning Centres and MFS.

Real estate owners suffer no such pressures. While the leverage used is usually higher for property transactions, so long as they are able to make regular interest (and sometimes principal) repayments, a borrower is able to keep their home, even if the value of their property is less than the loan amount. This means that not only will property prices move more slowly than share prices in a downturn, but property owners will be encouraged to retain their property (and keep paying the interest amounts) rather than sell it and have to dip into their own pockets to make up for the shortfall.

The third reason the property market is less efficient than the share market is that property owners are, generally, loath to sell their home. Aside from transaction costs, it is significantly more troublesome to move to another home than it is to sell shares in a publicly listed company. Moreover, rightly or wrongly, the home is considered a critical status symbol — to sell one’s home (even if financially, it is much wiser to rent) is (foolishly) considered an admission of financial defeat. Just as many Australia’s consider buying their home (no matter how over-priced) an indicia that they have “made it”, many consider selling a property and renting or moving to a smaller house a failure.

Real estate in Melbourne appears in the midst of a bubble — not altogether different to that experienced in some parts of the United States earlier this decade. The ratio of median-income to house prices in Melbourne is now about 6.9 — historically, that ratio has been around 3x. Melbourne’s median rental yield (based on APM and REIV data) is 3.4% on a gross basis — a net basis, that yield would probably slip below 2% — you can get triple the yield putting your money in the bank.

But don’t expect anything to change right away. Property is a slowly moving beast, but as Japanese and American home owners found it, is can be quite a terrifying one as well.