Will the bubble end?

I’d like someone to explain to me what happens to house prices and our economy when interest rates inevitably rise again.

When interest rates rise, so will house repayments for most people, even those on fixed mortgages will have less than 5 years respite at the most, but what will the consequences be? Investors will need more money to service their loans, but negative gearing will give them a larger tax break, and they can always put up rents. Owner occupiers, however, may be pushed beyond their capacity to service their mortgage ending in forced sales or foreclosures.

What I want to know is how the market will react in the scenario where we begin to see an increase in the number of people who can’t afford their mortgage? Will we see the bubble burst, with all of the flow on effects that we’ve seen in the US, UK and Europe, or will the equity rich investors simply concentrate the ownership of real estate further still and continue the bubble?

The combination of negative gearing, combined with the capital gains tax discount, seems to me to be distorting the market so much that my latter scenario doesn’t seem implausible. Would the banks tighten up lending if they saw more defaults, or would they double down on investors in an attempt to save the value of their assets? At what point would propping up the market become untenable? How much worse would the collapse be then?

The Australian real estate market looks to me like a financially ruinous game of chicken. If I’m wrong, I’d like to know why. If I’m right I’d like to know how the hell to get out of the way.