The tiny inner-city apartments built during the boom of the past decade are unlikely to meet the needs of Generation Y as they grow older.

Changing demographics over the next 10 years are tipped to drive demand for smaller dwellings — but not that small, according to BIS Oxford Economics.

The economic forecaster has crunched the population numbers and concluded that rapid growth in the 20-to-34-year-old age bracket over the past 15 years will see Generation Y, or millennials, shape the residential property market over the next decade.

As Generation Y move into their late 30s and 40s and are more likely to be living in family households with children, they will need to balance convenience and affordability with home ownership and the separate dwellings typically sought after in that life stage.

"For people who would like to remain in the inner or middle suburbs, that's going to be financially out of reach, so they'll be looking for something that offers more amenity but will be at a more affordable price," Angie Zigomanis from BIS Oxford Economics said.

"Probably the best type of dwelling that meets that compromise is a townhouse."

Bigger apartments, outdoor spaces 'missing from the market'

Investor demand has seen apartment construction boom — particularly in Sydney, Melbourne and Brisbane — but Mr Zigomanis said the studio, one and small two-bedroom apartments that are attractive to Generation Y as they rent in their 20s are unlikely to hold the same appeal as they age.

BIS Oxford expects the trend towards townhouse and apartment living to continue ( ABS, BIS Oxford Economics )

He is projecting increased demand for medium-density housing including townhouses, larger units and villas with at least three bedrooms.

Outdoor spaces, such as courtyards and rooftops, and more space inside, will also be in demand — something he said has been missing from the apartment market over the past decade.

BIS Oxford recently sounded an alarm over the residential building market, tipping the biggest fall since the GFC, led by a slump in high-density dwelling construction.

The large-scale, high-rise developments that sell apartments off the plan to investors do not hold the same appeal to owner-occupiers.

Mr Zigomanis expects those coming up behind Generation Y to continue to demand high-density apartments for rentals, but says growth will not be as strong as it has been.

"There's not going to be the need to build as many new apartments as we have been," he said, noting the next generation is a similar size to Generation Y.

Baby boomers tipped to add to townhouse demand

The growing over-65s segment of the population is not tipped to favour smaller apartments either.

BIS notes downsizing has been growing at a "glacial" pace and, even if it picks up, demand is not expected to be fulfilled by small, high-rise dwellings.

"Previous research that we've undertaken suggests that many baby boomers would still like to stay in the area that they're living in, where they've already made friends and social connections," Mr Zigomanis said.

The number of households in the 35-49 age bracket will increase over the next decade as Gen Y ages. ( ABS, BIS Oxford Economics )

"Their preference will be towards two and three-bedroom townhouse-type dwellings as well, similar to that being demanded by Gen Y.

"Between them they will create, from our point of view, more demand in those inner and middle suburbs for that medium-density-type product over the next decade."

Demand for medium-density housing is not as easy for developers to meet — apartment sites go up, but townhouse and villa-style developments require going out.

Disused industrial land or replacing detached houses on larger lots with multiple units could be a solution, according to Mr Zigomanis.