Rents will rise as house prices fall: Westpac

And while residential property sales may pick up a little in coming months as some property investors reorganise or quit the market, Westpac expects several years of subdued sales volumes and prices.

"Based on today's fundamentals, we'd say houses are only slightly overvalued," said the bank's chief economist, Brendan O'Donovan, after a fall of 12% in inflation-adjusted terms since 2007 when the housing market was "grossly overvalued".

"We are forecasting modest house price declines, in the order of 2% per annum, for 2010 and 2011."

However, different parts of the market would react differently, especially to the October tax changes, with the likelihood that rented, typically lower-value properties would fall in price while high income earners would have more disposable income after the tax cuts, underpinning high-end property.

The tax cuts would reduce the value of tax-deductible losses on rental properties, and Westpac predicts this will push rents 7% higher than they would have been without the tax cuts.

"Higher rents and lower house prices will tend to increase the rate of ownership," said Westpac, although these trends would take years to work their way through.

"Most likely, we will experience years of higher rent growth and weak house prices, rather than a big-bang adjustment as soon as the tax cuts are implemented."

The outlook for mortgage interest rates is another brake on house price inflation, as the low interest rates of the early 2000's would not be repeated in the tighter global lending environment emerging after the global financial crisis.

"Bank funding costs are much higher than they were last decade, and the Reserve Bank cannot use the Official Cash Rate (only now coming off an extended period at a historic low point) to shelter us from that forever."