Mortgage rates have surged uniformly across the country, going from just 3% in September 2021 to 7.33% as of Wednesday. However, the response from housing prices has been anything but uniform, leading to a fascinating divergence in the nation’s housing market. It’s really a tale of two housing markets, one red-hot at the bottom and another ice-cold at the top.

In many regional housing markets, higher-end homes have experienced price declines, while starter homes have remained relatively unscathed.

Seattle and San Francisco, two markets renowned for their high-priced housing markets, epitomize this stark contrast in home values. According to the Zillow Home Value Index, “upper price tier” home values have plummeted by 10.7% and 13.4%, respectively, in Seattle and San Francisco. Meanwhile, “lower price tier” home values have seen far milder declines, with decreases of just 1.5% and 4.1% in Seattle and San Francisco, respectively.

What’s going on? As housing affordability deteriorated across the country under the weight of higher mortgage rates, homebuyers simply adjusted their expectations. With the upper echelons of the market out of reach for many buyers, they’ve turned with attention to smaller and lower-priced homes. In doing so, they’ve kept the bottom half of the market relatively warmer.

Furthermore, many move-up buyers, who would be trading in a 3% or 4% mortgage rate for a 6% or 7% rate, have chosen to remain in their current homes. Consequently, this results in a reduced influx of move-up demand into the “upper price tier,” while simultaneously decreasing the supply available in the “lower price tier.”

In recent months, lower-priced homes have consistently outperformed their higher-end counterparts.

Among the nation's 40 largest housing markets tracked by Zillow, 29 markets remain below their pandemic-era price peak in the "upper price tier," while 23 are yet to regain those peaks in the "middle price tier." In contrast, just 10 markets remain below their pandemic peak in the "lower price tier."

Put another way, 30 out of the nation's 40 largest housing markets set all-time highs for "lower price tier" homes in July, underscoring the enduring appeal of more affordable housing options.

We've also witnessed this bifurcation manifest regionally, as high-cost Western markets like Phoenix and San Francisco have experienced overall price declines surpassing those of their more affordable Midwestern counterparts, such as Cincinnati and Chicago. Remarkably, home prices in 11 markets, including Cincinnati and Chicago, reached new all-time highs across price tiers in July. One significant reason for this shift is that individuals and investors who had been priced out of markets like San Francisco and Austin are redirecting their focus toward cities like Chicago, Cincinnati, and Kansas City.

In other words, there was a run on “relative affordability” in the first half of 2023. It resulted in lower price tiers experiencing more substantial price gains and "relatively affordable markets" outperforming their less affordable counterparts in terms of price increases.

Note: "Lower price tier" reflects the typical value for homes tracked by the Zillow Home Value Index in the 5th to 35th percentile range. "Middle price tier" reflects the typical value for homes in the 35th to 65th percentile range. "Upper price tier" reflects the typical value for homes in the 65th to 95th percentile range.