The National Association of Homebuilders (NAHB) credits demand for new homes, thanks to low existing inventory, for the increase in builder confidence in the month of July. The increase comes even as mortgage rates rise, construction costs remain elevated and limited lot availability haunts the industry.

The NAHB/Wells Fargo Housing Market Index (HMI) shows builder confidence in the market for newly built single-family homes posted a one-point gain to 56 in July, marking the seventh straight month that builder confidence has increased and the highest level since June of last year, according to the association.

“The lack of resale inventory means prospective home buyers who have not been priced out of the market continue to seek out new construction in greater numbers,” said NAHB chairperson Alicia Huey. “At the same time, builders are troubled over rising mortgage rates approaching 7% and continue to grapple with supply-side challenges, including ongoing scarcity of electrical transformer equipment and growing concerns about lot availability.”

Given that shelter inflation accounts for roughly 40% of the Consumer Price Index, NAHB chief economist Robert Dietz said the best way to ease this largest source of inflationary pressure is to build additional for-rent and for-sale housing.

“There’s been some commentary linking gains for housing construction with increased concerns for additional inflation, but this has the economics backwards,” Dietz said. “More housing supply is good news for future shelter inflation readings in the market. Furthermore, higher interest rates increase the cost of financing for building homes and developing lots.”

The July HMI survey also revealed that, despite elevated interest rates, builders’ use of sales incentives has declined as the market has firmed and resale inventory options remain limited. Only 22% of builders report cutting prices in July. This is down from 25% in June and 27% in May.

Derived from a monthly survey that NAHB has been conducting for more than 35 years, the NAHB/Wells Fargo HMI gauges builder perceptions of current single-family home sales and sales expectations for the next six months as “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.

The HMI index gauging current sales conditions in July rose one point to 62, the component charting sales expectations in the next six months fell two points to 60, and the gauge measuring traffic of prospective buyers increased three points to 40, the highest reading since June of last year. However, the decline for the future sales expectation reading is a reminder that housing affordability continues to be challenged by elevated interest rates, NAHB officials said.

“Although builders continue to remain cautiously optimistic about market conditions, the quarter-point rise in mortgage rates over the past month is a stark reminder of the stop and start process the market will experience as the Federal Reserve nears the end of the ongoing tightening cycle,” said Dietz.