* Housing starts fall 1.1 percent on single-family projects
* Permits rise 5.1 percent to highest level since Oct 2008
* Single-family permits highest since April 2010
* Residential construction to contribute to GDP this year
By Lucia Mutikani
WASHINGTON, March 20 (Reuters) - Permits for U.S. homebuilding neared a 3-1/2 year high in February, suggesting a budding recovery in the housing market was still on track even though groundbreaking activity slipped.
New building permits surged 5.1 percent to a seasonally adjusted annual rate of 717,000 units last month, the highest since October 2008, the Commerce Department said on Tuesday.
The jump in permits, which exceeded economists' expectations for an advance to a 690,000-unit pace, reinforced views the housing market was improving and that home building would add to economic growth this year for the first time since 2005.
"The data provides further evidence of a rebound in housing activity. Housing is being nursed back to health, but getting out of rehab takes time," said Eric Green, chief economist at TD Securities in New York.
Financial markets largely ignored the data.
While green shoots are emerging in the housing market, an oversupply of unsold homes is depressing prices and starts are still less than a third of the 2.27 million rate peak reached in January 2006.
In February, housing starts slipped 1.1 percent to a rate of 698,000 units, but there was more new construction activity in January than previously reported. Moreover, starts were up 34.7 percent from February last year, the biggest year-on-year rise since April 2010.
Construction of single-family homes - the lion's share of the market -- dropped 9.9 percent last month, but groundbreaking for multi-family housing projects soared 21.1 percent.
Over the past year, starts on single-family homes have risen 17.8 percent, while multi-family starts have nearly doubled as demand for rental properties has risen, with many Americans moving away from homeownership.
While home building now accounts for only about 2.5 percent of gross domestic product, it remains a major force in the economy. Economists estimate that for every one house built, about 2.5 jobs are created.
Permits last month were boosted by a 4.9 percent rise in approvals for single-family home projects to their highest level since April 2010. It was the fifth straight month that building permits for single-family homes had increased.
Permits usually lead home construction by about a month, meaning that starts will likely reverse their slide in March.
Permits for multi-family homes rose 5.6 percent to a 245,000-unit rate.
The data followed a report on Monday that showed sentiment among home builders held at a near five-year high in March.
"Builders are not just spending money on permits unless they absolutely intend to use them. We will see housing starts above 700,000 units next month," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.
"We are likely to see as much as a 20 percent increase in housing starts this year compared to last year. That is a healthy gain and it's going to add lots to jobs and lots to GDP and that's all that really matters," he said.