WASHINGTON (AP) - Construction of U.S. homes and apartments fell in July to the lowest level in more than 17 years, but some economists said the drop could aid the slumping housing sector by helping reduce a glut of unsold properties.

The Commerce Department on Tuesday said builders broke ground on 965,000 housing units on an annualized basis, down from a pace of 1.08 million in June and the weakest showing since March 1991.

However, July's performance was better than the 950,000 rate analysts expected.

The report showed that July construction of single-family homes fell by 2.9 percent from the previous month to a pace of 641,000. That was the lowest since January 1991, when the economy also was in distress.

Construction of apartments and other multifamily dwellings also fell sharply, after a large jump in June due to a change in New York City's building codes. That change, which went into effect July 1, gave a rare lift to overall housing construction in June.

Economists said the drop could help reduce the glut of unsold homes, a step toward turning around the slumping real estate market. Homebuilders are competing with foreclosed homes selling at steep price discounts.

"Slower starts means less adds to inventory," said Adam York, an economic analyst at Wachovia Corp. "We have too much supply on the market."

Last month, the Commerce Department said unsold new homes declined to a 10-month supply in June, down from a peak supply of 11.2 months in March, but still significantly above historic norms.

Inventories of existing homes, meanwhile, equaled an 11.1-month supply in June, the second highest level in 24 years, according to the National Association of Realtors.

Housing permits also fell steeply in Tuesday's report, a sign that housing starts likely will continue to decline, economists said.

Housing permits in July fell to a rate of 937,000, a 17.7 percent drop from June, but still above analysts' expectations of 925,000. Permits are considered a reliable sign of future activity.

"The correction in the housing market has yet to find its bottom," Richard Fisher, president of the Federal Reserve Bank of Dallas, said in a speech Tuesday.

New home construction last month was down a steep 39.2 percent compared with July 2007, illustrating how much ground the housing market has lost in the past year.

Homebuilders are hoping the housing rescue package approved by Congress last month will boost the dismal real estate sector. The law includes a temporary $7,500 tax credit for first-time homebuyers that essentially works out to a 15-year, interest-free loan.

The National Association of Home Builders/Wells Fargo housing market index, released Monday, remained at a record low of 16 in August for the second consecutive month. Readings below 50 indicate negative sentiment about the market.

But one measure of longer-term sentiment improved slightly: a measure of builders' sales expectations in six months rose two points to 25.

Still, homebuilder Toll Brothers Inc. reported dismal quarterly results last week when its revenue fell 34 percent and its order backlog plunged 52 percent.

Shares of several homebuilders, including Toll Brothers, D.R. Horton Inc. and Pulte Homes Inc., dropped in midday trading Tuesday.