The state budget expects spiralling home prices to peak towards the end of this year.
The budget also forecasts the home renovations boom will end in 2022 as borders reopen and people start spending again on overseas travel.
"A solid labour market has combined with low interest rates to drive up the number of property transactions, house prices and construction activity, despite the absence of new migration," the budget papers stated.
"Activity also has been stimulated by the Commonwealth's HomeBuilder scheme.
"House prices in Sydney have surged over 20 per cent since the onset of the pandemic.
"Renovation activity also has been strong as households have redirected money earmarked for overseas holidays into improving their houses.
"For now, these factors have been more than sufficient to offset the impact of weaker population growth.
"The current strength in the housing market, in terms of price growth and new construction, is mainly reflected in houses rather than units.
"Until recently, it had mainly been underpinned by demand from owner-occupiers."
The budget papers said government policies were supporting first home buyers, with first home buyer activity surging in the second half of 2020.
"The number of transfer duty concessions to first home buyers was up by more than a third in the second half of 2020 (at nearly 25,000), compared to a year earlier.
"Annual house price growth is expected to peak around late-2021.
"As higher prices encourage more owners to sell, this will work to limit house price growth over time.
"In addition, higher prices are expected to price out more potential buyers, weighing on demand."
The government dismissed speculation growing house prices could lead to a sharp rise in interest rates.
"The concentration of lending growth in owner-occupier loans (rather than investors) suggests the current market conditions are less likely to evoke a response from regulators," the budget papers said.
"For now, a significant macroprudential tightening is assumed to be unlikely, though this would change if speculative investor lending was to increase significantly.
"A major intervention would prompt a downward revision to house prices
from baseline, with broad implications for the economic outlook.
"Residential construction is expected to remain strong in the very near term, fuelled by higher house prices, ongoing policy support and low interest rates.
"Meanwhile, demand for renovations is expected to drop off in 2022 as discretionary household expenditure is redirected back toward international travel once the border reopens."