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When Will the First-Time Homebuyer Step Forward?

Tickers in this article: DIA IYR SPY XHB

NEW YORK (TheStreet) -- The housing market has been on fire for the last several months but don't tell that to a first-time homebuyer.

Many young couples in their 20s and 30s who want to buy a home are struggling to get a mortgage under tough credit conditions. Others find themselves fighting a losing battle with cash-rich investors over low-priced homes.

To make things worse, a sudden rise in interest rates coupled with rising home prices has now also made buying a home a lot more expensive.

First-time homebuyers accounted for just 29% of home purchases in June, according to the National Association of Realtors (NAR), down from 32% a year ago. Historically, their participation rate has been close to 40%.

Rather, the housing recovery has been chiefly driven by investors. Cash sales accounted for 31% of all sales in June, according to NAR, with individual investors accounting for 17% of all purchases.

Investor participation has been higher than normal in this recovery, thanks to a large number of distressed properties hitting the market. Investors are usually attracted to these kinds of homes, as they can buy them at a steep discounts, fix them up and sell them for a profit or rent them out for an attractive yield.

Investors have helped absorb much of the excess supply in the market and have helped lift housing off the bottom.

But the low participation of first-time homebuyers has raised concerns about the sustainability of the housing recovery.

First-time homebuyers are viewed as fundamental to the health of the housing market. Their demand allows existing homeowners to "trade up," thus fueling greater housing turnover.

Plus, investors will exit as prices rise and returns diminish. What happens then? Will first-time homebuyers step up to fill the void? Or will flat incomes, an uncertain economic outlook and higher interest rates deter them?

Bank of America Merrill Lynch economist Michelle Meyer said she believes that the share of first-time homebuyers will go up as the housing market normalizes over time.

As the pipeline of distressed properties decreases -- the share of distressed sales was at its lowest level since October 2008 in June -- the economics for investors will become less attractive, she told TheStreet. There will be fewer bargains. Higher interest rates will also increase financing costs and other investments will start to look more attractive in a higher rate environment.