* Construction sector shrunk by 50 pct during downturn

* New activity not enough to fill gap for Spanish economy

* Builders, banks pick fewer, stricter projects after crisis

* Market focusing on premium areas in big cities

By Sonya Dowsett

MADRID, Dec 14 (Reuters) - On a street in central Madrid, Juan Jose Perucho points to where he is going to build one of the capital's tallest residential blocks after buying a site bigger than five football pitches from the state-owned metro network.

"We've sold faster than ever before on this development," says the head of unlisted real estate company Grupo IBOSA of the project, which will feature a 25-floor tower with swimming pool and hanging gardens.

"I've seen nothing like it in all my 24 years in this business."

Spain is building again after seven years of a crushing downturn in the construction sector with investment in house-building registering its first quarterly rise since before the crisis in the three months from June to September.

But while this is a sign of Spaniards' confidence in their recovering economy, construction is unlikely to return to pre-crisis levels, leaving a shortfall in economic activity which has yet to be replaced by any other sector.

Spanish construction accounts for 5 percent of the country's output compared to 10 percent in the boom years, or an annual shortfall of about 50 billion euros ($62 billion), and employs less than half than before the housing crash of 2008, with no quick prospect of a sharp rebound.

At the peak of its decade-long building bonanza, Spain was putting up more houses per year than Germany, France and Italy combined. This has left a stock of 740,000 unsold new homes, hard to shift as many stand in out-of-town areas like Guadalajara and La Rioja where demand for housing is weak.

Banks, with 161 billion euros homebuilder debt weighing on balance sheets, much of it soured, are highly cautious about lending to projects and are focusing on high-end developments in Madrid and Barcelona where prices are rising.

Developers must show half the flats have been sold off-plan before sealing financing deals. They must also buy the land with their own money and put half of their own capital into building costs, lenders say.

Even under such strict conditions, the amount of projects is up from last year, mostly because of the dynamism of Madrid and Barcelona. In Madrid, the city council issued 3,131 building permits for residential use in the first 10 months of 2014, more than it awarded in the whole of 2013.

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New building is planned for prime real estate plots like former Ministry of Defence land in the exclusive Madrid neighbourhood of Chamberi, which another unlisted property company Domo bought in November and where it plans to build 355 flats in a gated development with swimming pool and shops.