Builders broke ground on fewer U.S. homes in May than anticipated after the expiration of a tax credit, indicating the real-estate market will struggle without government incentives.

Housing starts fell 10 percent, the biggest decline since March 2009, to a 593,000 annual rate, Commerce Department figures showed today in Washington. Building permits, a sign of future construction, unexpectedly fell to a one-year low. Single-family starts suffered the largest drop since 1991.

Builders focused less on taking on new projects and more on completing houses for those seeking to qualify for the tax credit, which required contracts be signed by April 30 and closed by the end of this month. Growth in sales and construction will now depend more on job gains and a drop in foreclosures, which have pushed down prices and created competition for builders.

"Builders are obviously feeling very cautious, justifiably cautious, given the only moderate speed of the recovery so far and the concern is that home buying will pull back on the other side of the tax credit," said Robert Dye, a senior economist at PNC Financial Markets Group Inc. in Pittsburgh. Home construction in the third quarter is "going to be weak and will be a drag on" the economy, he said.

Economists forecast starts would fall to a 648,000 annual rate, according to the median of 78 projections in a Bloomberg News survey. Starts in April were at a revised 659,000 pace, less than previously reported. Estimates for May ranged from 575,000 to 698,000.

Production Rises

A separate report from the Federal Reserve showed industrial production in May rose by the most since August. Output at factories, mines and utilities increased 1.2 percent last month after a 0.7 percent gain in April.

The figures show the recovery is being led by manufacturing as companies rebuild inventories, invest in new equipment and sell more goods abroad.

Stocks fell after the report, with the Standard & Poor's 500 Index dropping 0.6 percent to 1,108.09 at 9:32 a.m. in New York.

The Labor Department reported today that wholesale prices fell in May for the third time in four months. Prices paid to factories, farmers and other producers declined 0.3 percent after April's 0.1 percent drop. Excluding food and fuel, so- called core prices climbed 0.2 percent for a second month.

Building permits were projected to rise to 625,000, according to the Bloomberg survey.

Starts were up 7.8 percent from the same month last year, while permits increased 4.4 percent.

Single-Family Starts

Construction of single-family houses slumped 17 percent, the biggest drop since January 1991, to a 468,000 pace in May. Permits declined 9.9 percent after a 10 percent drop in April. Work on multifamily homes, such as townhouses and apartment buildings, jumped 33 percent to an annual rate of 125,000.

Two of four regions had a decrease in starts last month, led by a 21 percent slump in the South and a 6.3 percent decline in the Northeast. Single-family starts were down in all regions.

The number of homes under construction declined to a 475,000 annual rate in May, the lowest on record.

Under the government's incentive program, which was renewed and expanded in November, buyers had to sign contracts by the end of April and close on homes by June 30 to qualify for a credit worth as much as $8,000. Banks usually require homes to be livable before they agree to a closing.

Senator Harry Reid last week proposed a three-month extension to the closing deadline amid concern that a rush of buyers created too big a backlog for builders to complete projects by the end of this month. An extension would support housing starts and construction in coming months.

Home Sales

Helped by the credit, sales of new homes surged in April to a 504,000 rate, the highest level in two years, according to Commerce Department data. The increase brought the number of homes on the market down to 211,000, the fewest since 1968.

Even so, home sales and construction will be more dependent in coming month on the labor market. While employment has increased for six of the last seven months, job gains in May were less than forecast and the unemployment rate remains near a 26-year high.

A report yesterday showed builders became more pessimistic this month. The National Association of Home Builders/Wells Fargo Housing Market Index fell to 17, from 22 in May. Readings below 50 signal more builders view the market as poor.

Hovnanian Enterprises Inc., the largest homebuilder in New Jersey, earlier this month reported that it closed on 1,197 homes with an average price of $287,050, compared with 1,459 houses for an average $277,053 a year earlier. Orders for new homes fell 17 percent and contract signings in May were slower.

Sales Pulled Forward

"Our slower pace of May net contracts seems to confirm that the tax credit helped pull some sales forward into earlier months this year," Ara K. Hovnanian, chairman and chief executive officer, said in the statement. "We recognize that the expiration of the federal homebuyer tax credit, the lack of job growth and a potential increase in foreclosures all pose risks to a housing industry recovery."

Some builders are optimistic. Toll Brothers Inc., the largest U.S. luxury homebuilder, said May 26 it increased its land holdings for the first time in four years in anticipation of a recovery in the market. The number of houses under contract but not yet sold rose in the three months ended April 30 compared with a year earlier for the first time since 2006, the Horsham, Pennsylvania-based company said.

"People are not as scared any longer that a house is a lousy investment," Chairman Robert Toll said on a conference call.