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US House Prices To Continue Falling: Economist

The second leg of the US housing downturn will continue throughout the year and could be nasty if a vicious circle of falling prices and rising foreclosures continues, according to Capital Economics.

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"The second downward leg in house prices that began last year will continue throughout this year and take prices to a new cycle low, some 5 percent below current levels," Paul Dales, a senior economist at Capital Economics, said.

"Incredibly favorable valuations and exceptionally low mortgage rates will not prevent this fall in prices. Valuations and affordability are much less important when demand is constrained by poor economic conditions and the effects of the previous plunges in asset prices," Dales explained.

In the US, 25 percent of households are in negative equity with another 25 percent not having enough equity to qualify for a new mortgage, said Dales, who also warned that those who can move are less likely to do so as prices fall.

Even rising sales will not stop the fall in prices, he added.

"Rising employment and incomes will mean that home sales will continue to edge up from their still depressed levels. The existing market will continue to outperform the new market, as buyers are attracted to heavily discounted foreclosed homes," Dales said.

"Rising home sales will not prevent prices from falling either. Even though sales rose in the 1990s, prices still fell," he added.

With well over 5 million homes either up for sale or in the foreclosure pipeline, the rental market could be strong, according to Dales.

"The good news is that some of the vacant supply may be rented out. After all, the fact that rental demand is rising and rental supply is already tight means that for the next few years the rental market will be the best performing part of the residential market," he said.

"For the first time since 1986, rentals yields are likely to rise above their long-run average of 5 percent. Falling house prices, though, will mean that gross rental returns remain below 10 percent," Dales said.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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