A growing population will not be enough to stave off a fall of up to 7 per cent in house prices over the next 18 months warns investment bank Citi.
In a detailed report, analysts Paul Brenna, Josh Williamson and Vivian Jang predict that moves by the Australian Prudential Regulation Authority (APRA) to cool housing would be more effective than previous attempts and would compound other factors in the market.
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They conclude that a "partial correction" is likely for Sydney and Melbourne and that the unwinding of the housing boom could pose a wider challenge for the economy.
"Given the stretched house price valuations in Sydney and Melbourne some correction would seem likely as supply continues to catch up to demand," the report says, forecasting prices will fall by about 7 per cent through 2018.
"Our model of house prices includes measures of underlying demand and supply for housing, with the dwelling stock growing faster than population, and the model also includes household debt. It suggests that the run up in house prices was facilitated by rising household debt."
That means that if APRA is successful in limiting growth in household debt and consumers became increasingly cautious about the market, "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," the report says.
"In our view the largest price falls would be higher rise, inner city apartments in Brisbane and Melbourne given their greater potential for oversupply."
![The housing market is becoming overcooked.](/web/20170508190657im_/http://www.theage.com.au/content/dam/images/g/v/p/d/2/9/image.related.articleLeadwide.620x349.gvyc7c.png/1493802320616.jpg)
The Reserve Bank of Australia has repeatedly warned about imbalance in those apartment markets most recently on Tuesday in its decision to leave interest rates on hold.
The Citi analysts said correction in prices would pose challenges for the broader economy but would not be a disaster.
![The housing market provided a 30 per cent increase in household wealth in the past three years.](/web/20170508190657im_/http://www.theage.com.au/content/dam/images/g/v/x/v/f/n/image.related.articleLeadwide.620x349.gvyc7c.png/1493802320616.jpg)
"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," it says.
They note that housing had played a key role in propping up the economy as the mining boom wound off and provided a 30 per cent increase in household wealth in the past three years.
The economy now faces a second rebalancing challenge as the housing boom begins a protracted unwinding.
"The economy now faces a second rebalancing challenge as the housing boom begins a protracted unwinding.
"Drivers of the housing boom are being replaced by tighter lending standards, higher lending rates, reduced foreign investment and increased supply relative to demand.
"The heavy reliance on housing to rebalance the economy after the mining boom has created its own financial stability and macroeconomic risks."We expect these risks could be more challenging to manage than during the unwind of the mining boom."
The report also warns APRA's measures can be "blunt".
"By applying tighter lending standards across all markets this should take some heat from the Sydney and Melbourne markets but intensify the weak housing market in Perth and weak Brisbane apartment market," it says.