June 01, 2010, 10:46 AM EDT By Shobhana Chandra

June 1 (Bloomberg) -- Construction spending in the U.S. rose in April by the most since 2000 as demand related to the end of a tax credit spurred builders to break ground on more houses.

Sales boosted by a government incentive of as much as $8,000 helped reduce the number of unsold new houses in April to the lowest level in more than three decades, spurring housing starts. While government construction also increased for a second month, spending may be limited by tighter state and local budgets.

“The turn in housing is encouraging,” Michael Englund, chief economist at Action Economics LLC in Boulder, Colorado, said before the report. “We’ve cleared away enough new homes inventories that at least we can add some construction. Non- residential construction is still quite weak.”

The gain in April was the biggest since August 2000. Estimates of 53 economists surveyed by Bloomberg ranged from a drop of 1 percent to an increase of 2 percent, after a previously estimated gain of 0.2 percent in March.

Factory Index

A separate report showed manufacturing expanded in May for a 10th month. The Institute for Supply Management’s factory gauge fell less than forecast to 59.7 from 60.4 in April, which was the highest level in almost six years. Readings greater than 50 signal expansion.

Stocks gained as the reports helped the market erase an early drop triggered by concern that China’s economic expansion is slowing. The Standard & Poor’s 500 Index rose 0.3 percent to 1,093.04 at 10:39 a.m. in New York.

Construction spending decreased 11 percent in the 12 months ended in April.

Private construction spending rose 2.9 percent, the most since July 2004. Homebuilding outlays jumped 4.4 percent, the biggest gain since October 2009. Private non-residential projects increased 1.7 percent, the most since September 2008 and led by factories and power facilities.

Spending on public construction rose 2.4 percent from the prior month. Federal construction spending increased 2.9 percent, while state and local government outlays rose 2.3 percent.

Home Sales

Sales of new homes surged in March by the most since 1963 as buyers rushed in before the tax credit expired. The jump in demand brought the number of new houses for sale down to 228,000, the lowest since March 1971, Commerce Department figures showed last month. Builders broke ground on homes at a 672,000 annual rate in April, the most since October 2008.

Toll Brothers Inc., the largest U.S. luxury homebuilder, increased its land holdings for the first time in four years in anticipation of a housing recovery. The Horsham, Pennsylvania- based company also said the number of houses under contract but not yet sold rose in the three months ended April 30 for the first time on a year-over-year basis since 2006.

“People are not as scared any longer that a house is a lousy investment,” Chairman Robert Toll said on a conference call on May 26.

Job Creation

Sustained improvement in housing, the weakest part of the economy, will require job creation and a drop in foreclosures, which have been returning more homes to the market, pushing down prices and competing with new houses.

The economy grew at a 3 percent annual rate in the first quarter, slower than previously calculated, government figures showed last week. Spending on structures, including office buildings and factories, dropped at a 15.3 percent pace, while homebuilding declined at an 11 percent rate.

Commercial real estate is getting hurt by high vacancy rates and excess capacity at factories. Vacancies at offices, shops and warehouses will rise until at least the end of this year on lingering effects of the economic slump, the National Association of Realtors said on May 26. Annual office rents will fall 2.3 percent in 2010 and 2.1 percent next year, the Realtors group said.

State governments are under increasing pressure to shrink gaps in their budgets. Lawmakers in Illinois on May 28 approved a $25.9 billion emergency general fund budget that cut spending by about $1.3 billion. They didn’t raise taxes or reduce outlays enough to close a $13 billion deficit.

In Texas, where the deficit may rise as high as $18 billion in the next two-year cycle according to state officials, Governor Rick Perry last week asked state agencies, boards and universities to propose 10 percent spending cuts in requests for the 2012-2013 fiscal years.