Sales of previously owned U.S. homes hit a seven-month low in June as demand for condominiums fell and contract cancellations surged, dampening hopes the distressed housing market was starting to improve.

The National Association of Realtors said on Wednesday sales fell 0.8 percent last month from May to an annual rate of 4.77 million units, the lowest since November and a third straight monthly fall.

Economists had expected sales to rise to a 4.90 million-unit pace.

The drop in sales was surprising given that pending home sales contracts rebounded in May. On Tuesday, a report showed home construction in June jumped to a six-month high.

Pending home sales are drawn from a small sample and become actual sales with a lag of a month or two.

Contract cancellations were the chief driver behind June's drop in sales, the group said, though it could not give a specific reason. However, it noted the sluggish economy, especially the weak labor market and tight lending conditions.

Buyers and sellers are increasingly running up against conservative appraisals, which often cause deals to fall through or be delayed, said Mark Vitner, senior economist at Wells Fargo Securities in Charlotte, North Carolina.

CANCELED CONTRACTS ON THE RISE

Canceled contracts rose to a 16 percent rate from 4 percent in May. That was the highest since the Realtors started tracking cancellations last year and was well above the usual rate of 9 percent to 10 percent.

Jay Piro, an agent in Nutley, New Jersey, said he has seen contract cancellations rise to 30 percent of his would-be sales in the last six months, mostly involving homes for sale by banks after their owners failed on their mortgages.

Buyers walk away from those properties because banks are too overwhelmed by foreclosures to process them quickly, Piro said. Other deals flop when lenders get nervous about a buyer's credit-worthiness or when buyers get cold feet about inspection problems -- from termites to oil tank issues.

Things that used to fly in a normal deal because purchasers were so anxious to own property, today they back out, said Piro, who works for realty firm Remax.

While cancellations have been the trend in the last couple of years, the spike in June took industry analysts by surprise. They had not seen a similar pattern with pending contracts for new home sales, they said.

Cancellations have been ongoing, it's not a one-month trend, said Jonathan Smoke, head of research at Housing IntelligencePro in Washington. On the builders side, we have not seen a corresponding change in cancellations. If anything, they have been moderating on the new home contracts side.

June's drop in sales drop could add to concerns about the economy's ability to rebound this quarter after stumbling badly in the first half of the year.

The decline in sales last month was concentrated in condominiums, with single-family home sales flat. Single-family homes account for a large portion of the home resale market.

Weakness in housing, still struggling with an over-supply of for-sale and foreclosed properties, is a drag on growth.

Data next week is expected to confirm the economy lost further momentum in the second quarter after a pedestrian 1.9 percent annual growth pace in the January-March period.

PURCHASE MORTGAGE APPLICATIONS DIP

Data on mortgage applications offered little hope that sales would rise much in the months ahead.

Demand for home purchase loans dipped last week but low mortgage rates boosted applications for refinancing.

There were some glimmers of hope in the Realtors' report, with home prices rising despite the weak sales pace and an increase in inventory. The median home price climbed 0.8 percent in June from a year earlier to $184,300.

Some economists attributed the rise to a shift in the mix of sales away from condominiums and purchases by first-time home buyers. They said higher pricing could encourage more home building in the months ahead.

Prices rose in the Northeast and West, which are typically expensive markets.

June's sales pace pushed the supply of existing homes on the market to 9.5 months' worth, the highest since November, from 9.1 months' worth in May. A supply of between six and seven months is generally considered ideal.

Foreclosures and short sales, which typically occur below market value, made up 30 percent of transactions last month, slipping from 31 percent the prior month. All-cash purchases accounted for 29 percent of transactions in June.

(Reporting by Lucia Mutikani in Washington; additional reporting by Alexandra Alper in New York; Editing by Neil Stempleman and Dan Grebler)