April 18 (Bloomberg) -- Builders started work last month on the smallest number of new houses in a year, as rising mortgage rates and record inventories of unsold homes discouraged new projects.

Housing starts declined 7.8 percent in March to an annual rate of 1.96 million, from 2.126 million in February, the Commerce Department said today in Washington. Building permits, a sign of future construction, fell 5.5 percent to an annual rate of 2.059 million from 2.179 million.

Builders are breaking ground on fewer projects after new home sales declined in three of the last four months, falling in February by the most in nine years. Construction companies such as KB Home report fewer orders as increased borrowing costs and higher prices put new homes out of the reach of more Americans.

``It's clear that the housing market is cooling,'' Joel Naroff, president of Naroff Economic Advisors, in Holland, Pennsylvania, said before the report. ``There are areas of the country where we are going to see pretty sharp declines in construction and in housing prices.''

The number of new homes started during March was the smallest since March 2005.

Economists expected housing starts to fall to an annual rate of 2.03 million in March from the prior month's originally reported 2.12 million, according to the median of 57 forecasts in a Bloomberg News survey. Estimates ranged from 1.9 million to 2.15 million.

Permits were forecast to fall to a 2.1 million pace, from 2.145 million, according to the median of 26 estimates in a Bloomberg survey. Projections ranged from 1.93 million to 2.21 million.

Single-Family

Starts of single-family homes fell 12 percent last month to a 1.591 million-unit rate. Builders started work on multifamily homes such as townhouses at an annual rate of 369,000, an increase of 16 percent.

Starts fell in all regions of the country. They decreased 16 percent in the West to an annual rate of 486,000, 8.2 percent in the Midwest to 291,000, 4.8 percent in the South to 994,000 and 0.5 percent in the Northeast to 189,000.

The number of homes under construction fell 0.8 percent last month to a 1.415 million pace from 1.427 million. Housing completions increased 7.8 percent to 2.218 million units at an annual rate, the most since June 1973.

The number of housing units authorized, but not yet started, rose 9.5 percent to 235,600.

The average 30-year-fixed mortgage rate rose to 6.5 percent last week, the highest in almost four years, according to the Mortgage Bankers Association. That compares with an average of 6.38 percent in March. The 30-year fixed rate has averaged about 7.46 percent since 1990.

The National Association of Realtors' April forecast calls for housing starts to slow 3.2 percent this year and for new home sales to decline 11 percent.

Builder Optimism

Optimism among U.S. homebuilders fell this month to the lowest level since November 2001, The National Association of Home Builders said yesterday. Since October, the group's gauge of optimism has fallen the most in any six-month period since it began in 1985.

``There are reasonably deep-seated reasons for pessimism on the part of home builders,'' said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., a New York forecasting firm.

Increased borrowing costs contributed to a 21 percent drop in new home sales during the five-month-period running through February, when the annualized pace of contract signings fell to a three-year-low of 1.08 million units. The number of unsold homes reached a record 548,000 dwellings.

``Buyers are going to be in a sweet spot in about three to six months,'' said Anthony Chan, chief economist at JPMorgan Chase & Co.'s private client services group. ``The speculators who are still holding properties will be panicking by then as their carrying costs mount. It won't be a bloodbath, but that's when prices should be at their lowest.''

Speculative Purchases

Chan estimates that speculative purchases make up 20 percent of the housing market. These are typically homes purchased by buyers looking to resell them quickly at a sizeable profit, rather than consumers purchasing a long-term residence.

Federal Reserve policymakers have been encouraging banks to tighten lending standards in recent months and make less use of tools favored by speculative home buyers, such as adjustable-rate and no-interest mortgages. These loans become more costly as the federal funds target rate increases.

The Fed has raised that rate, which serves as the nation's benchmark, to 4.75 percent from 1 percent since June 30, 2004.

``We're seeing that the investment side of housing looks like the edge is coming off because the carrying cost of doing these investments is getting higher,'' Federal Reserve Governor Susan Bies said March 31.

The housing slowdown means residential investment will subtract 0.4 percentage point from the rate of economic growth this year and lead to the loss of 80,000 jobs in the mortgage industry, according to the Mortgage Bankers Association.

Gross domestic product will probably rise 3.4 percent this year, according to the median forecast of 75 economists surveyed by Bloomberg News April 3-7.

Job creation is averaging 196,670 jobs a month so far this year. The U.S. needs to create about 150,000 jobs a month to keep pace with new entries to the labor force, according to Nariman Behravesh, chief economist at Global Insight Inc. in New York.

Homebuilders are started to see the slowdown in their orders.

KB Home, the fifth-largest U.S. homebuilder by market value, reported a 12 percent decrease in orders in the December-February period. The decline was the first in four years at KB Home.

``Some housing markets have moderated from the over-heated and, in some cases, speculative pace of growth of the past few years,'' Bruce Karatz, chief executive of KB Home, said in the March 22 statement. ``Tempering of demand to more sustainable long-term levels is a healthy trend.''

To contact the reporter on this story: Victor Epstein in Washington vepstein@bloomberg.net

Last Updated: April 18, 2006 08:30 EDT