The four-bedroom house that Ilia Nielsen-Dembe purchased in west Denver earlier this year wasn't her top choice. The first-time buyer had to settle on a home in a neighborhood with a high crime rate after losing out on bids for five properties in more desirable areas.
"I definitely sacrificed in terms of location," said Nielsen-Dembe, 33, who lives with her husband and two daughters in the house she bought in April for $184,500. "I had to cross streets that were not ideal in order to get a house."
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While the supply of U.S. homes for sale is at an almost two-year high and price gains are moderating, buyers such as Nielsen-Dembe wouldn't know it. An inventory crunch for entry- level houses has only worsened during the past year as discounted foreclosures become scarce and cash-paying investors snap up affordable listings to convert to rentals. Properties at the lower end of the market are also the most likely to have underwater mortgages, keeping would-be sellers from moving.
"There is inventory coming on line, albeit slowly," said Nela Richardson, chief economist for Redfin, a Seattle-based brokerage. "The problem is it's not equally distributed. There is more turnover at the higher end. At the more affordable end of the spectrum, people are stuck."
The number of U.S. homes for sale in the bottom third of the market -- below $198,000 -- fell 17 percent in June compared with a year earlier, according to a Redfin analysis of 31 large U.S. metropolitan areas. The supply was up 3 percent in the middle market and jumped 15 percent at the top, the data show.
The inventory of all existing homes for sale rose 6.5 percent in June from a year earlier to 2.3 million, an increase from a 13-year low of 1.8 million in January 2013, according to the National Association of Realtors. That's a 5.5-month supply at the current sales pace, less than the six months that is considered equilibrium between buyers and sellers.
The rising inventory of more expensive properties is giving a boost to sales and easing the bidding wars of the past two years as historically low mortgage rates fueled competition for a short supply of homes. At the bottom of the market, first-time buyers, even those with the credit, savings and income to overcome tougher underwriting requirements, must face off against other bidders, ready to pounce.
In Denver, entry-level listings in June were down 51 percent from a year earlier, while the upper-end supply was up 4 percent, according to Redfin. Austin, Texas, inventory jumped 14 percent in the top third of the market and fell 34 percent at the bottom. In Atlanta, where Wall Street-backed investors descended to buy homes to turn into rentals, low-end supply declined 13 percent. Top-third listings rose 18 percent.
"It's bad news for people looking for a starter home that all the choices are disappearing," Lawrence Yun, chief economist at NAR, said. "People shouldn't expect inventory to show up on the low end. It's not available."
Competition in the entry-level market intensified during the past few years as Blackstone Group LP and other Wall Street investors paid cash to absorb foreclosed homes from Florida to Arizona. Today, fewer properties are available to buy because many investors are holding them as long-term rentals. Foreclosures and short sales, in which the borrower sells for less than what's owed, accounted for 11 percent of transactions in June, down from 15 percent in June 2013, data from NAR show.
Average list prices on the low-end jumped 15 percent in June from a year earlier, and increased 13 percent in the middle and 9 percent at the top, according to Redfin's analysis of large metro areas.
"If you see prices increasing for reasons other than fundamentals, it's not good for affordability," Hui Shan, a housing analyst with New York-based Goldman Sachs Group Inc., said. "A lot of it has to do with investors coming into the market and buying properties. Those are not related to local residents' incomes going up."
Sharlene Hensrud, a Realtor with Re/Max Results in Plymouth, Minnesota, said buyers of cheaper homes have had to adjust expectations because the bargains have been picked over.
She recently took a couple on a tour of homes for about $140,000 and said they were quickly discouraged that a one- bedroom, one-bath house with no garage was all they could afford. A few years ago, a three-bedroom property would have been in their range, Hensrud said.
In June, there was only a 2.8-month supply of properties in the $120,000 to $150,000 range in the Minneapolis area, down from a year ago, according to the Minneapolis Association of Realtors. By comparison, there was 4.6 months of inventory of homes for $250,000 to $350,000, and a 6.3 month supply for $350,000 to $500,000 -- both higher than a year ago.
"Inventory does play a role," Hensrud said. "When we were in the middle of the crash, there were so many foreclosures. The foreclosure levels have dropped so much."
Some properties aren't available because homebuyers are taking advantage of the strong rental market and leasing out their previous homes.
Others who want to list their houses can't. Owners of inexpensive houses are three times more likely than those with costly homes to owe more than their property is worth, according to Zillow Inc. About a third of mortgaged homes in the bottom price tier were in negative equity in the first quarter, compared with 18 percent in the middle and 11 percent at the top, Zillow data show.
Values of the bottom third of homes in June were 17 percent below their pre-recession peak, while top-tier properties were off by 8.6 percent, according to Seattle-based Zillow. Owners in lower-cost neighborhoods are also more likely to be underwater because many of them took out zero-down payment mortgages during the boom or refinanced and pulled equity out, said Mark Vitner, senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina.
A slowdown in price gains means that it will take longer for underwater homeowners to regain enough equity to sell and have a sufficient down payment to buy something else, said Richardson of Redfin.
Residential real estate prices rose 9.3 percent in the 12 months ended May, the slowest pace in more than a year, according to the S&P/Case-Shiller 20-city index. The gauge, which fell as much as 35 percent in the real estate crash, has increased 27 percent from a March 2012 low.
"So many people bought during the peak of the boom that they still have very low equity in their home," Richardson said. "They need prices to go up even further because they bought or refinanced at top of the mountain and we haven't reached those heights."
First-time purchasers accounted for 28 percent of all sales of previously owned homes in June, down from about 40 percent historically, according to NAR.
The contrast is starker in the new-housing market, where homebuilders are focusing on move-up buyers. In May, homebuilders reported that only 16 percent of new-home purchases were made by first-time buyers, the lowest in 15 years of data, according to David Crowe, chief economist for the Washington- based National Association of Homebuilders. That's further limiting supply as builders shift away from constructing entry- level homes.
Tight credit has made it more difficult for young buyers, who have relatively high unemployment, weak wage growth and lower credit scores, Crowe said.
The supply of cheaper new homes "isn't there because young people are still up against these financial barriers," Crowe said. "The builders are responding to the customer that is active in the market. It will be at least two years before there is a measurable change in the share of sales going to first-time homebuyers."
Nielsen-Dembe, a nursing assistant who took on two full- time jobs to qualify for her mortgage, said she wanted to buy because she was tired of the relatively high costs of renting. She expected getting financing to be her biggest challenge.
Instead, she struggled with finding a single-family home in her price range. It took six months because of heated competition. Three of the houses she bid on went instead to cash buyers.
She found sellers who needed a flexible buyer because the house they were moving to wasn't going to be ready for two months.
"I was willing to wait however long they needed," she said.