SYDNEY, Dec 21 — Offshore hedge fund managers and priced-out young Australians have long argued the pace of house price growth in the nation’s biggest cities is unsustainable. They may finally be right.

After two years of double-digit growth, the Sydney house price index gained just 3.2 per cent in the year to September, the weakest increase since 2012, according to the latest government data. Melbourne’s rise of 6.9 per cent was the slowest in more than a year.

The dip comes amid increased warnings from the central bank of a looming oversupply of inner-city apartments, with Morgan Stanley analysts saying there could be a surplus of 100,000 units by 2018.

Fitch Ratings this month cut its outlook for the Australian banking sector, citing “key risks” around the housing market, while a measure of consumer confidence in property is the lowest in a year.

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“I just don’t think it can continue,” Paul Dales, chief Australia and New Zealand economist at Capital Economics Ltd. in Sydney said by phone. “Overall market conditions aren’t really consistent with this strength going much further.”

Australia’s biggest banks, whose loan books are dominated by property, have taken note. The cost of borrowing for property investors is on the rise as the banks begin to reprice credit.

Westpac Banking Corp, Commonwealth Bank of Australia, Australia & New Zealand Banking Group Ltd and National Australia Bank Ltd increased their mortgage rates for landlords by between seven basis points and 15 basis points this month.

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After peaking at 31,546 commencements in March, the surge in apartment building is starting to fall back — an illustration that developers are also facing a more difficult lending environment.

ANZ Bank Chief Executive Officer Shayne Elliott told shareholders at the annual general meeting this month that the bank is reducing “exposure to CBD, inner-city apartments, because we are a little concerned about some of the risks there.”

Tighter lending standards for property investors and foreign buyers, together with capital controls by Chinese authorities, have compounded the slowdown, according to Paul Bloxham, chief Australia economist at HSBC Holdings Plc in Sydney.

“The Australian housing market is cooling,” Bloxham wrote in his 2017 housing outlook late last month. “Tighter prudential settings and a pull-back in foreign demand are expected to weigh on prices, particularly of apartments.”

Still, few are predicting an outright crash as record low interest rates and population growth underpin the market. Helping fuel price gains is a shortage of properties in desirable suburbs, which in turn feeds competition among buyers.

Auction clearance rates in Sydney and Melbourne hit 77 and 80 per cent respectively in the week ending Dec 11, while the combined capital clearance rate has now been over 70 per cent for the past 20 weeks, the strongest run since 2009, according to CoreLogic Inc.

HSBC is forecasting price rises of between four and six percent in Sydney next year and two percent to four percent in Melbourne. With the Reserve Bank of Australia’s official cash rate at 1.5 per cent and forecast by markets and economists to remain on hold next year, that’s still a healthy investment.

“Average Australian investors need strong and stable returns,” Michael Yardney, director of property investment and management firm Metropole Property Strategists, said by phone.

“There are not many other asset classes other than residential property that offer that,” he said, while cautioning that the era of every property making money is over.

The continued confidence in the market can be seen in the recent uptick in lending to investors, which shrank last year as the banking regulator sought to limit growth in such loans to avert a bubble.

Mortgages to investors accounted for 49 percent of all dwellings financed in October, according to government data, up from 44 per cent in December 2015.

Yardney says local confidence that the market won’t crash, even if it slows, comes down to two things: Wealth and immigration.

Australia is the second-wealthiest nation in the world per adult, according to Credit Suisse Group AG, and its points-based immigration system means it favors younger, skilled migrants.

“There has not been enough building in Australia for 10 years, particularly Sydney, so while yes, there are pockets of concentrated risk, the underlying demand in the big metropolitan areas is solid," said Bill Salouris of Sydney-based Challis Capital Partners, whose firm recently raised A$100 million (RM325 million) from Asian investors for mid-sized residential developments around the country.

Dales says he sees only three factors that could could prompt an outright crash: A huge hike in interest rates, a widespread spike in unemployment or a massive slowdown in China.

“I just don’t think you are going to get a collapse in the overall market when interest rates are still relatively low,” he said, but cautioned that there is “scope for adjustment” when rates do finally rise significantly.

“Not a US style outright collapse, but some kind of brake on the housing market, where prices fall modestly for a couple of years rather than rise.” — Bloomberg