Morgan Stanley's forecasting team was among the first to predict the downturn could run to 10 per cent following curbs to negative gearing and the capital gains tax discount in the May budget.
But the investment bank said the backdrop had since worsened.
Dwelling prices have already fallen 5.2 per cent since a peak in March, according to data provider Cotality, which means the slide could be only one-third complete.
The Reserve Bank's four rate rises in 2026 have been more than expected and markets predict at least one more hike.
"As such, we now expect national house prices to fall 10-15 per cent from their peak, with a trough in the second half of 2027," Morgan Stanley analysts said in a note to clients.
"This would be Australia's largest nominal housing downturn in over 40 years.
"Interest rates remain the key sensitivity of the depth of the downturn from here."
Morgan Stanley was looking at five indicators that would signal the market was bottoming out.
Either markets would have to start pricing in rate cuts, government policy would have to ease, home sales would have to rise relative to listings, auction clearance rates would have to turn up or owning a home would have to become cheaper than renting.
"We do not expect these factors to turn before mid-2027, which is why we see a trough in the second half of 2027," they said.
Morgan Stanley estimated budget tax changes would account for about five per cent of the expected 10-15 per cent peak-to-trough fall.
Once the downturn was finished, the recovery in prices was likely to be flatter than in previous cycles, because of falling migration levels and lower expectations for capital gains among investors, they said.
Lower house prices combined with rising construction costs are squeezing the feasibility of new residential developments.
The housing downturn would directly cause a slowdown in building activity and indirectly cause a slowdown in broader economic activity.
Because construction accounted for about nine per cent of employment, it could result in unemployment rising to 5.1 per cent, Morgan Stanley said.
It also threatened to further derail the nation's housing supply ambitions.
Australia only completed 355,817 dwellings in the first two years of its goal of building 1.2 million new homes in five years, meaning the sector is about 124,000 homes behind schedule.
Construction costs increased 3.2 per cent in the 12 months ended September, up from 2.8 per cent in 2025/26, according to data released by Cotality on Wednesday.
It was the second consecutive quarter that construction costs grew by one per cent, following a 0.2 per cent rise in March quarter.
Elevated fuel prices were adding directly to the costs plumbers faced to get from site to site, and indirectly through delivery costs of building materials, Master Plumbers Australia and New Zealand chief executive Nathaniel Smith said.
"They're getting hit twice," Mr Smith told AAP.
Price movements across categories of building materials were mixed, except for plastics, which increased across the board.
Gyprock was another strong contributor to cost growth.
But the overall pace of cost growth remains well below long-term historical averages.
While prices of PVC and HDPE pipes went up by as much as 40 per cent in March, prices had since come down as domestic manufacturers found alternative sources of plastic that did not need to travel through the Strait of Hormuz, Mr Smith said.
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