House prices could fall by as much as 7% over the next two years in a "partial correction" as supply catches up to demand and regulators stem the flow of household debt, Citi has warned.
In a note this week, the investment bank warned that a correction was "likely", with the risks related to the unwinding of the housing boom potentially "more challenging to manage" than the end of the mining boom.
"Given the stretched house price valuations in Sydney and Melbourne some correction would seem likely as supply continues to catch up to demand," Citi analysts wrote.
They argue that the recent moves by regulators to limit growth in interest-only mortgages would have a "much more meaningful impact" than an earlier 10% cap on investor lending.
"Our model ... suggests that the run up in house prices was facilitated by rising household debt," they wrote.
"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.
"In our view 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.
"Slowing Chinese investment in the market, with lower levels of foreign investment applications to FIRB, and possibly lower immigration add to these risks, as would further out-of-cycle lending rate rises."
It comes after UBS last week also called the top of the current housing cycle, but stopped short of predicting price falls.
"While the historical trigger for a housing downturn (of RBA hikes) is missing, mortgage rates are rising, and sentiment of home buying collapsed to a [near] record low," UBS analysts wrote.
A survey of 34 economists and experts by comparison website Finder.com.au earlier this week found more than half agreed that the housing market had peaked.
Data from research firm CoreLogic showed Sydney price growth was flat in April and rose only slightly in Melbourne.
The soft result came after dramatic capital gains in the second half of 2016 and first three months of 2017, which saw Sydney dwelling values surge 11.3% and Melbourne 12.6%.
"APRA's tightening measures probably contributed to the April prices result, but Easter and school holidays may also have contributed to the slowdown," Citi analysts wrote.
"Time will tell and we doubt that the RBA and APRA will rush to judgment."
HARVEY NORMAN FACING HOUSING HIT
In the event of a housing slowdown, retailers would feel the brunt of the impact, as housing turnover is a large driver of consumer spending in DIY home renovation, new appliances, AV equipment and furniture.
Citi points to the last house price slowdown - when prices fell nationally by five per cent over 18 months between June 2010 and December 2011 - in which both Harvey Norman and JB Hi-Fi took a major sales hit.
"Harvey Norman has the largest share price downside to a housing correction," Citi analysts wrote.
"We assume Australian franchisee sales decline by five per cent and earnings decline by 28 per cent in a housing downturn scenario."
While JB Hi-Fi's legacy business has "limited housing exposure", with a predicted sales decline of 1% in a housing slowdown, the retailer's acquisition of The Good Guys has "increased its exposure to housing materially".
"Appliances now account for 26 per cent of group sales, up from four per cent prior to the acquisition.
Similarly to Harvey Norman, we expect The Good Guys sales to decline by 5% under this scenario."
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