updated 6/19/2007 12:38:02 PM ET 2007-06-19T16:38:02

Construction of new homes fell in May as the nation’s homebuilders were battered by the crisis in subprime lending and rising mortgage rates.

Housing, which is struggling through its biggest downturn in 16 years, is expected to continue to face troubles in the months ahead before starting to stage a sustained rebound in 2008.

The Commerce Department reported Tuesday that construction of new homes and apartments dropped by 2.1 percent last month to a seasonally adjusted annual rate of 1.474 million units, 24.2 percent below the level of a year ago.

The May decline was in line with expectations and reflected weakness in the South and West, which offset construction gains in the Northeast and Midwest.

Permits, considered a good barometer of future activity, rose by 3 percent in May but that followed a huge 7.1 percent plunge in April. The strength last month came from a rebound in permits for apartment construction, which can be volatile. Applications for single-family homes fell by 1.8 percent and have been down four of the past five months.

“The downward trend remains firmly in place and there is no prospect of any near-term relief, given the huge inventory overhang in the new home market,” said Ian Shepherdson, chief U.S. economist for High Frequency Economics.

Home builders, struggling to reduce record levels of unsold homes, are slashing prices and offering a variety of sales incentives, such as kitchen upgrades and free decks, to do so.

However, they are facing new problems with the recent spike in mortgage delinquencies, which means that more homes are being dumped on the market, and a steady rise in mortgage rates over the past month, with Freddie Mac’s national survey for 30-year mortgages hitting an 11-month high of 6.74 percent last week.

The National Association of Home Builders reported that its survey of builder sentiment sank in June to the lowest level in 16 years, a reading of 28, down from 30 in May. The three major components of the index — sales, sales expectations and buyer traffic — all posted declines. It was the lowest showing since February 1991, a period that covered the last major housing recession.

“The tightening in lending standards is having quite an impact,” said David Seiders, chief economist for the home builders. He predicted that home sales would likely fall further in coming months with a sustained rebound not occurring until 2008.

Seiders said he looked for construction of new homes and apartments to decline by 22 percent this year after having fallen by 13 percent in 2006.

It had appeared that the slump in housing was hitting bottom at the end of last year, but there has been a renewed drop in recent months triggered by problems in the mortgage industry. The level of late payments and foreclosures on subprime mortgages hit record highs in the first three months of the year, according to a survey by the Mortgage Bankers Association.

The percentage of payments that were 30 or more days days past due for subprime mortgages — loans made to borrowers with weak credit histories — rose to a record 15.75 percent in the January-March quarter.

Housing had enjoyed a five-year boom fueled by the lowest mortgage rates in four decades and soaring home prices that drove investors to get into the market. That boom ended in 2006 and since that time sales of both new and existing homes have been falling and home prices in the hottest markets are down as well.

Construction of single-family homes dropped 3.4 percent last month while construction of apartments rose by 3.1 percent.

By region of the country, construction activity fell by 19.7 percent in the West and 1.6 percent in the South. Construction was up 15.7 percent in the Northeast and 15.5 percent in the Midwest.

The steep slump in housing has weighed on the overall economy, dragging growth down to a barely discernible rate of 0.6 percent in the first three months of this year.

Analysts believe growth in the current quarter has rebounded to a more respectable rate of 3 percent or even better, despite the ongoing problems in housing.

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