Key Points:

• Mortgage rates are expected to remain above 6 percent, but affordability may improve modestly due to positive wage growth and slightly lower rates.
  
  
• Inventory will remain historically low, with a slight increase expected if mortgage rates moderate. However, the mortgage lock-in effect will prevent a return to pre-pandemic inventory levels.
  
  
• The pre-pandemic, five-year average pace of existing-home sales was 5.4 million (SAAR). Based on the average annual pace of sales from 2022 through 2024, we’re cumulatively approximately 3 million sales short of the pre-pandemic normal.

In our 2024 outlook, we predicted: “If the 2020-2021 housing market was ‘too hot,’ then the 2023 market was probably ‘too cold,’ but 2024 won’t yet be ‘just right.’” This forecast proved accurate. Despite the Federal Reserve beginning its rate-cutting cycle in September, mortgage rates have remained above 6 percent, keeping affordability constrained. The average pace of existing-home sales in 2024 struggled to surpass 4 million, while national housing inventory remained historically low. Will 2025 be the year the housing market moves closer to being ‘just right’? As with all things in economics, the answer is ‘it depends.’ 

“The 2025 housing market is poised to make strides forward – offering progress, but still far from perfection.”

Prediction 1: Mortgage Rates will Remain Above 6 Percent, but Affordability will Improve

The outlook for the 2025 housing market heavily depends on the path of inflation, the health of the economy, and the Federal (Fed) Reserve’s monetary policy. While the Fed began its rate-cutting cycle in 2024, sticky inflation and a resilient economy may prompt a pause in rate cuts early this year. The most likely scenario in 2025 is that that the economy and labor market continue to cool, but not collapse. And, if the Fed’s own projections are correct, we may see up to two rate cuts in 2025, down from the four they envisioned in September. Two rate cuts still keeps policy restrictive because the fed funds rate would still be above the Fed’s estimate of “neutral.” As the Fed maintains a ‘higher-than-goldilocks’ stance, mortgage rates likely will also remain above 6 percent. However, mortgage rates may drift lower from 2024 levels, in part driven by some narrowing of the mortgage rate spread as the Fed’s policy outlook becomes clearer. 

A resilient labor market is likely to keep wage growth positive, while nominal house price appreciation moderates. This dynamic could allow nominal wage growth to exceed house price growth. Slightly lower rates alongside positive wage growth could result in modest improvements in affordability.

Prediction 2: House Prices to Moderate, but Remain Positive Nationally

According to First American Data & Analytics’ November 2024 Home Price Index, house prices nationally continued to reach new heights in 2024, but the pace of price growth was a steady 3.9 percent. As the housing market adjusts to the new normal of higher mortgage rates, buyers and sellers are gradually returning, supported by a healthy labor market and more homes for sale compared to last year. The result is steady, single-digit house price growth, reflecting a market returning to normal following the pandemic-to-post-pandemic roller-coaster ride.

As indicated in the chart below, house price growth and total months’ supply have an inverse relationship. Historically, six months of supply is associated with moderate price appreciation, but a lower level of months’ supply tends to push prices up more rapidly. Total months’ supply improved in 2024, but remained consistently below five months, putting upward pressure on prices. In 2025, total months’ supply may increase modestly, but it is not expected to get back to ’normal.’ Therefore, if this relationship between months’ supply and home prices repeats itself, house price growth will remain positive, but in line with historical averages between 3 to 4 percent. 

Prediction 3: Inventory will Remain Historically Low 

The end of 2024 did bring with it some positive news: new- and existing-home inventory picked up. According to our analysis, the total inventory of existing homes for sale relative to the total number of households, or “inventory turnover,” has historically averaged about 2.5 percent – or 250 homes per 10,000 are on the market at any given time. Inventory turnover began 2024 at a rate of 1.2 percent but ended the year at 1.3 percent. The uptick was due to an increase in both new- and existing-home inventory. As existing-home owners became more comfortable with the “higher-for-longer” rate environment, more decided to put their homes on the market. It’s important to note that the pickup in listings was more prevalent in Sun Belt markets, particularly Florida and Texas. If rates moderate in 2025, we expect inventory to pick up slightly. However, given our mortgage rate outlook for rates to stay above 6 percent in 2025, still-constrained affordability and the mortgage lock-in effect will prevent inventory from making a return to pre-pandemic norms. 

Prediction 4:  Existing-Home Sales will Improve, but Stay Below ‘Normal’ Levels

Inventory of existing homes has been trending higher and the consensus industry expectation is that mortgage rates will drift modestly lower this year. Additionally, there remains significant pent-up demand for homes from first-time home buyers and repeat buyers alike. Consider that the pre-pandemic, five-year average pace of existing-home sales was 5.4 million (SAAR). If you calculate the average annual pace of sales from 2022 through 2024, we’re cumulatively approximately 3 million sales short of the pre-pandemic normal – that’s a lot of missing sellers and buyers that are waiting to jump into the market. While the mortgage rate lock-in effect will prevent a full recovery, the journey back to a normal housing market should accelerate in 2025. 

Prediction 5: The New-Home Market will Outperform

The inventory of new homes for sale is at the highest level since 2007, while the inventory of existing homes for sale remains near historical lows. The latter is a result of the “golden handcuffs” of low mortgage rates, as over 80 percent of mortgaged homes have a rate below 6 percent and are financially disincentivized from selling their home. Builders do not face such a constraint and will do whatever it takes to sell their inventory. Builders are not only benefitting from a lack of competing resale inventory, but they also can offer incentives, such as mortgage rate buydowns or even price cuts, to entice buyers. According to analysis from NAHB, 31 percent of builders cut home prices in December, the average price reduction was 5 percent, and the use of sales incentives was 60 percent. When there are no suitable existing homes for sale, a new home with a rate buydown can be a good alternative. This relative outperformance of the new-home market will vary geographically, as single-family new home construction is concentrated in Sun Belt metros.

Progress, Not Perfection

While the pandemic housing market was defined by an overall heating of the U.S. housing market, the theme for 2025 will be a shift towards more localized market dynamics. Markets with more building and inventory will experience greater affordability relief, which will, in turn, allow for increased sales. However, the 2025 housing market will continue to face significant headwinds preventing a return to “normal.” Mortgage rate volatility will persist until the Fed’s policy outlook becomes clearer, and the mortgage rate lock-in effect will prevent a full housing market recovery. Nevertheless, the 2025 housing market is poised to make strides forward – offering progress, but still far from perfection.