A decline in property investment and foreign buyer activity is expected to reduce house price growth to just 1 per cent over the next two years.

Key points: NAB predicts house price growth of 1 per cent nationally this year

NAB predicts house price growth of 1 per cent nationally this year Unit prices expected to fall 1.2 per cent this year

Unit prices expected to fall 1.2 per cent this year Foreign buyers and local investors make up a falling share of the market

National Australia Bank's latest residential property survey, taken in late 2015, shows sentiment and expectations amongst real estate market participants at +1.

That is down from +10 in the third quarter of 2015, and well below the long-term average of +13.

NAB said sentiment weakened most noticeably in New South Wales and Queensland, but was lower across the country.

Victoria now has the nation's strongest market sentiment and is the only state tracking above its long-term average, a finding that concurs with recent home price data from CoreLogic RP Data.

Despite Victoria leading sentiment, survey respondents predicted that Queensland would have the largest home price gains over the next two years (at 1.9 and 2.7 per cent).

Victorian prices were expected to creep 0.7 and then 1 per cent higher over 2016 and 2017, with New South Wales forecast to see no growth and South Australia/the Northern Territory (combined) and Western Australia expected to continue seeing modest price falls.

"Weakening fundamentals have already seen the market starting to cool, suggesting the best of the price gains are probably behind us," commented NAB's chief economist Alan Oster.

Overall, real estate industry participants expect house prices to increase an average 0.5 per cent nationally this year and 1 per cent over the next two.

However, NAB's forecasts are a little more optimistic, suggesting 1 per cent growth this year and little chance of severe price falls.

"Our overall assessment is that the possibility of a more severe correction in the Australian housing market is still remote, although the risks have escalated over the past six months," noted the report.

"Nevertheless, a sharp correction will likely require an external catalyst, triggering a sharp deterioration in the local labour market and/or a wave of Chinese selling."

Reduced demand from local and foreign property investors

Two factors appear to be driving the weaker outlook - a reduction in demand from local investors and a decline in foreign buying.

NAB said the percentage of established properties being sold to local investors fell from a survey high of 25.2 per cent in the third quarter of 2014 to a record low of 19.2 per cent last quarter.

The decline corresponds with tighter rules from the Australian Prudential Regulation Authority that have limited the growth in lending to property investors.

The other big slowdown came from foreign buyers, who accounted for 14.4 per cent of all new property sales in the fourth quarter, down from 15.7 per cent the previous quarter, and 8.6 per cent of established property sales.

The only state where foreign buyer activity increased was Queensland, while overseas purchasers remained fairly active in New South Wales.

However, there was a significant decline in foreign buyer activity in Victoria, where non-resident purchases fell from 25.2 per cent of all new property sales to 16.4 per cent, and from 15 per cent of established homes to 8.6 per cent.

The decline coincides with the stricter enforcement of rules regulating which properties non-resident purchasers can buy, and tougher penalties for breaches.

NAB says an apartment glut amid weaker investor and foreign demand will see unit prices fall 1.2 per cent. ( Audience submitted: Edwin Almeida )

The new rules took effect from December 1, with an amnesty before that date for illegal buyers who came forward, thus it is likely to have an even bigger impact in the first quarter of 2016.

Australia's foreign investment rules for residential real estate generally restrict overseas buyers to purchasing newly built properties, with the ability to buy an established property only if they are living in it.

However, as a Parliamentary inquiry into the regime found, the rules were rarely enforced and routinely breached without sanction.

Mr Oster said the uncertainty over foreign demand, plus a surge in apartment construction (largely fuelled by overseas demand - 53 per cent of foreign purchases were apartments), has muddied the real estate outlook.

"Aside from the strong supply response in the apartment sector, a greater reliance on foreign buyers adds a degree of unpredictability to the outlook, both positive and negative," he warned.

NAB is predicting that a looming oversupply of apartments, especially in Melbourne and Perth, combined with weaker foreign demand and immigration will see apartment prices decline 1.2 per cent this year, with flat to falling values in every capital city.

The report is based on a survey of around 250 real estate participants, including agents, asset managers, developers and investors.