What is the Absorption Rate in Real Estate?
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Understanding the Absorption Rate in Real Estate
The absorption rate in a real estate market can tell the story of supply and demand. This market indicator is primarily used by real estate professionals in presentations to clients, typically in the form of a CMA report or by investors who are looking to see which direction the real estate market is headed. It could be market specific or simply an overall view of the real estate market during a specific time period.
The real estate market absorption rate is calculated by dividing the number of homes sold in the allotted time period by the total number of available homes. This equation can also be reversed to identify the amount of time it would take for the supply to be sold.
How to Calculate the Current Real Estate Market Absorption Rate?
The real estate market absorption rate is calculated by dividing the number of homes sold in the allotted time period by the total number of available homes. This equation can also be reversed to identify the amount of time it would take for the supply to be sold.
Examples of Absorption Rate in Real Estate
Typically, an absorption rate above 20% has signaled a seller's market and an absorption rate below 15% is an indicator of a buyer's market.
Let’s assume there are 200 new construction properties currently available in Westport, CT. Last month, 10 new construction properties were sold in Westport, CT. If we calculate 200/10=20, in this given example, it would take 20 months to sell the currently available new construction properties in Westport, CT. This assumes a steady market condition. If we reverse the calculation, 10/200=5%, the market seems to indicate that Westport, CT is a buyer’s market for new construction.
Suppose Westport, CT has 2,000 properties currently listed on the market for sale. If buyers purchased 500 properties last month, the absorption rate for last month is 25% (500 properties sold last month divided by 2,000 homes available for sale). This also is an indicator that the current supply of homes shall be exhausted in 4 months (2,000 homes divided by 500 homes sold/month). In this example, Westport, CT is a seller’s market.
How is the Absorption Rate Used in Real Estate?
In the real estate market, the absorption rate provides insight into how quickly or slowly houses are selling. It helps real estate professionals see trends in the market. Therefore it is used by developers to determine if the market is ready for new construction projects. A realtor can also use the Absorption Rate to establish price for a new listing. If the rate is low, a real estate agent may be forced to reduce a listing price for a client to attract a sale. Alternatively, if the rate is high, the agent can increase the price without sacrificing demand for the property. The absorption rate is also important for buyers and sellers as they make their decisions on the timing on when to buy or sell.
You must be aware that the Absorption Rate assumes steady market conditions. There are other factors to consider such as time of the year, spring vs winter, or events that are taking place in a particular market. It is also wise to check the financial news to see where the market can be headed and always remember that one indicator shall not be solely relied upon.