WASHINGTON (Reuters) - U.S. single-family homebuilding surged to a five-month high in September, but permits for future construction rose only marginally amid excess supply of new homes on the market and prospective buyers holding out for lower mortgage rates.

Despite the second straight monthly increase in single-family housing starts, economists expected that residential investment, which includes homebuilding and sales, was a small drag or had a neutral impact on third-quarter economic growth.

Home building suffered a setback following a surge in mortgage rates in the spring. Mortgage rates initially dropped after the Federal Reserve began cutting interest rates last month, but they have risen over the past three weeks as solid economic data, including retail sales and annual revisions to national accounts, forced traders to abandon expectations for another 50 basis-point rate cut next month.

"Residential construction activity is not helping the economy grow at its potential rate," said Carl Weinberg, chief economist at High Frequency Economics.

"'Falling' interest rates are different than 'low' interest rates until they have been falling for a while. For builders and buyers, the promise of more rate cuts to come will encourage delaying new construction projects and purchases."

Single-family housing starts, which account for the bulk of homebuilding, increased 2.7% to a seasonally adjusted annual rate of 1.027 million units last month, the Commerce Department's Census Bureau reported on Friday. Data for August was revised higher to show single-family homebuilding rebounding to a rate of 1.0 million units from the previously reported 992,000-unit pace.

Starts for this segment rose 6.6% in the densely populated South and jumped 10.6% in the Northeast. But they fell 10.4% in the Midwest, which is considered the most affordable region, and dropped 2.3% in the West.

Single-family homebuilding advanced 5.5% from a year ago.

New construction has benefited in recent years from a dearth of previously owned houses on the market, prior to the spring resurgence in mortgage rates, which sidelined prospective buyers and pushed the supply of new homes on the market to levels last seen in 2008. Potential homebuyers have also been reluctant to wade back into the market, anticipating even lower borrowing costs.

A National Association of Home Builders survey on Thursday showed a moderate improvement in homebuilder sentiment in October. It also showed a slight rise in the share of builders using incentives such as price cuts to attract buyers.

LOW BUILDING PERMITS

Starts for housing projects with five units or more declined 4.5% to a rate of 317,000 units in September. Overall housing starts slipped 0.5% to a rate of 1.354 million units. Economists polled by Reuters had forecast starts would decrease to a rate of 1.350 million units. Housing starts fell 0.7% from a year ago.

Homebuilding could suffer a temporary setback from the impact of Hurricanes Helene and Milton, which devastated Florida and large areas of the U.S. Southeast in late September and early October. But rebuilding after the hurricanes could provide a lift for homebuilding.

Building permits for single-family housing rose 0.3% to a rate of 970,000 units last month. Permits were 1.2% lower compared to September 2023.

Multi-family building permits plunged 10.8% to a rate of 398,000 units. Building permits as a whole declined 2.9% to a rate of 1.428 million units. They fell 5.7% from a year ago.

Residential investment subtracted from gross domestic product in the second quarter.

The number of houses approved for construction that were yet to be started dropped 0.7% to 282,000 units last month.

The single-family homebuilding backlog fell 2.1% to 143,000 units. The completions rate for that housing segment declined 2.7% to 1.0 million units.