House prices could fall as much as 7 per cent by 2018 as lending curbs bite and household debt is lowered, according to Citi.
Hardest hit potentially would be apartments in inner-city Brisbane and Melbourne, which are more threatened by oversupply than other housing sectors.
The forecast from Citi comes as the first signs of cooling in the housing market emerge with the latest figures showing prices in Sydney and Melbourne slowed in April.
The wide-ranging 47-page analysis by a team of Citi analysts examines potential ramifications for the economy and major companies as the housing boom unwinds.
That unwinding is being driven by tighter lending standards, higher lending rates, reduced foreign investment and increased supply relative to demand.
Sentiment towards real estate compared with lowering debt had "soured" even before the latest efforts by the Australian Prudential Regulation Authority to rein in lending to investors, according to the Citi analysts.
"APRA's tightening measures probably contributed to the April prices result, but Easter and school holidays may also have contributed to the slowdown," the Citi analysts wrote in their research this week.
"Given the stretched house price valuations in Sydney and Melbourne some correction would seem likely as supply continues to catch up to demand.
"The largest price falls would be higher rise, inner city apartments in Brisbane and Melbourne given their greater potential for oversupply.
"Either way, we aren't expecting large enough price falls to trigger a downturn in the economy, but the downside risks have risen as house prices and household debt have continued to increase briskly."
Adding to those risks are other potential brakes including slowing Chinese investment in the market, the possibility of lower immigration, along with out of cycle lending rate rises as banks hike the cost of hundreds of loan products.
The Citi modelling takes into account household debt and its impact on rising house prices.
"If APRA succeeds in limiting further rises in household debt and ultimately we see some mild deleveraging, there could be a partial correction in house prices during the course of the next two years.
"This would be the case even if population growth remained strong."
Signs of a cooling market are already being factored in by the Victorian government, which this week became the first of the state governments to unveil its 2017-18 budget.
Victoria's Treasury already expects growth in its stamp duty take to taper this year and next as rising borrowing costs and tighter controls on investor lending take a toll on the real estate market.
It is not only state coffers that will be affected by an unwinding housing market.
A downturn in the housing market will flow through into lower dwelling investment by 2018, although this year activity will be insulated by the existing construction pipeline.
And there are implications for consumer spending if house prices fall materially, which will likely crimp household wealth, according to Citi.
Big retailers could potentially be affected including JB Hi-Fi and Harvey Norman, which delivered negative returns of 35 per cent and 39 per cent respectively when house prices last moderated in 2012.
"While no two periods are identical in terms of industry trends and macro impacts, this period provides an indication of retailer sales, earnings and share price leverage to falling house prices," the analysts wrote.
