Housing starts and permits for future home construction fell in April as an overhang of homes on the market discouraged builders from taking on new projects, pointing to prolonged weakness in the housing sector.

The Commerce Department said on Tuesday housing starts dropped 10.6 percent to a seasonally adjusted annual rate of 523,000 units. March's starts were revised up to a 585,000-unit pace from the previously reported rate of 549,000 units.

Economists polled by Reuters had forecast housing starts rising to a 568,000-unit rate. Compared to April last year, residential construction was down 23.9 percent, the largest decline since October 2009.

Starts in the South slumped to a two-year low.

We're still struggling to find the bottom here for the housing market. It does not bode well for construction in the near term, and there's a good deal of overhang in terms of inventory, said Michael Woolfolk a senior currency strategist at BNY Mellon in New York.

U.S. stock futures turned negative after the housing data, while Treasury debt prices turned higher.

Residential construction is being crowded out by an oversupply of used homes on the market, in particular, foreclosed properties, which sell well below their value.

In March, the spread between the prices of new and previously owned houses was about $54,200.

Home builders' sentiment was flat in May, the National Association of Home Builders said on Monday.

Though builders expected a modest improvement in sales during spring, they anticipated market conditions to weaken in the next six months.

Residential construction accounts for about 2.2 percent of gross domestic product. Investment in home building contracted in the first quarter after a modest increase in the last three months of 2010.

Groundbreaking last month was depressed by a 24.1 percent tumble in the volatile multi-family homes sector, where starts for buildings with five or more units dropped 28.3 percent. Single-family home construction fell 5.1 percent.

New building permits dropped 4.0 percent to a 551,000-unit pace last month. March's permits were revised down to a 574,000-unit pace and economists had expected overall building permits in April to remain unchanged at the previously reported 585,000-unit pace.

Permits were held down last month by an 8.8 percent drop in the multi-family segment. Permits to build single-family homes slipped 1.8 percent.

New home completions rose 4.1 percent to 554,000 units in April.

(Reporting by Lucia Mutikani, Editing by Andrea Ricci)