Rice urged Israel to stop expanding settlements, deemed illegal under international law, arguing that they were not helpful to the peace process.
"The settlement activity is not conducive to creating an environment for negotiations," Rice said at a news conference with Mahmoud Abbas, the Palestinian president, in the West Bank city of Ramallah.
Earlier in Jerusalem, after talks with Tzipi Livni, the Israeli foreign minister, Rice referred to settlements, saying "anything that undermines confidence between the parties ought to be avoided".
A US-backed "road map" for peace calls on Israel to halt all settlement activity in the West Bank and for Palestinians to rein in armed groups.
Settlement 'noise'
The report by Peace Now, a non-governmental organisation, said that at least 2,600 new homes for Israelis are currently under construction in the West Bank, an increase of 80 per cent over last year.
In occupied East Jerusalem, which Palestinians want as the capital of their future state, the number of new government bids for construction has increased from 46 in 2007 to 1,761 so far this year.
Palestinians say the construction of Israeli homes undermines final status talks as it runs counter to earlier agreements.
But Tzipi Livni, the Israeli foreign minister, said the construction will not affect talks.
"The peace process is not, and should not be, affected by any kind of settlement activities," Livni said.
Livni urged the Palestinians not to use settlement building "as an excuse" to avoid negotiations, but added she understood "their frustration" at times.
Peace process
Nour Odeh, Al Jazeera's correspondent in Ramallah, said the issue of settlement building played into larger concerns.
"The issue of settlement building is not just that they exist on occupied land in the West Bank and occupied East Jerusalem, it's about control over water and the territorial contiguity of any possible future [Palestinian] state," she said.
"It's difficult for Palestinians to have any confidence in the committment to reach a solution when settlement activity has almost doubled - and by the Palestinain count more than doubled."
Rice said she still aims to reach a peace accord by January, when George Bush, the US president, leaves office, but she has played down chances of striking any partial accord in time for the September UN General Assembly.
Egypt talks
Separately, Ehud Barak, Israel's defence minister, travelled to Egypt on Tuesday where he met Hosni Mubarak, the Egyptian president, to discuss the ceasefire in Gaza that has been in effect since mid-June.
Barak hailed Egyptian efforts along the porous border which "have visibly been effective", a statement from the Israeli defence ministry said.
But Barak also said that "more effort should be put in order to further reduce" weapons smuggling into Gaza.
The two leaders also discussed ways to renew talks on the release of Gilad Shalit, an Israeli soldier captured by Hamas fighters near Gaza in June 2006.
On Monday, Barak ordered the closure of all border crossings into Gaza after two rockets were fired from the strip.