The U.S. housing market is moving in two distinctly different directions, according to a new Zillow report that reveals surging demand for luxury homes alongside softening sales in the starter home segment.

Zillow classifies starter homes as properties falling within the 5th to 35th percentile of home values in a given region, while luxury homes sit in the top 5%. Nationwide, the typical starter home is valued at approximately $202,000, reflecting a 2.3% year-over-year increase. The typical luxury home, by comparison, is valued at about $1.9 million, representing a 3.1% annual gain.

Inventory trends further illustrate the divide. Starter home inventory rose 4.5% year over year in June, while luxury home inventory declined 5.2%. The starter home inventory gain comes after years of persistent underbuilding in that segment, which has kept supply historically tight even as conditions show tentative signs of easing. Price reductions were also more prevalent among starter homes, with 25% of such listings seeing price cuts in June, compared to 20.6% of luxury listings.

"The best time to buy a home is when nobody else wants to," said Kara Ng, senior economist at Zillow. "Starter home buyers today have more options, more negotiating power, and sellers who are more willing to deal."

Prospective starter home buyers, however, are navigating a challenging economic landscape. Elevated inflation continues to strain household budgets, consumer sentiment remains low, and the job market is cooling. Mortgage rates, while off their 2023 peaks, remain well above the sub-3% levels that prevailed during the pandemic-era buying boom, adding to the affordability burden for price-sensitive households. These combined pressures typically lead households to postpone major financial commitments such as purchasing a home, the report noted, even when favorable conditions exist for buyers.

"The challenge is that the same financial pressures making it harder to save for a down payment are also making it harder to take advantage of that opportunity," Ng added.

The picture looks markedly different for higher-income households. Stock market gains have strengthened their purchasing power and helped fuel robust demand for luxury properties. The divergence underscores a broader wealth effect in housing: households with existing assets benefit from market appreciation, while those relying on wages face steeper barriers to entry.

Nowhere is the market divergence more pronounced than in San Francisco, where luxury home sales surged 21.6% year over year in May, accompanied by a sharp drop in inventory and fewer price reductions. Conversely, starter home sales in the San Francisco metro area fell 1.2% year over year in May. Price cuts were more than twice as common among starter homes, with 22.2% of listings seeing reductions in June compared to 9.4% of luxury listings.

Among metro areas, the largest year-over-year increases in starter homes sold as of May were recorded in Louisville (19.3%), New Orleans (12.9%), San Jose, California (10.5%), and Miami (8.2%).

The strongest year-over-year growth in luxury home sales as of May was seen in Memphis (42.4%), Nashville (40.8%), Cincinnati (32.6%), Austin (27.7%), and Birmingham, Alabama (25%).

Source: Zillow report via Fox Business