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Impact of the Absorption Rate in Real Estate
Absorption rate in real estate is a critical marker that lets consumers know if it's a good time to buy or sell. It can be easily calculated by..
Madison Clifton
Jun 4, 2019
Absorption rate can sound complicated, but it’s a really simple calculation used across the real estate industry to determine the number of homes sold vs the number of homes available. It is mostly commonly used to determine conditions like “a seller’s market”, and can be critical for builders and other industry professionals, along with the regular buyer and seller.
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What Does Absorption Rate Tell Me?
Within real estate, absorption rate provides a distinct understanding of the current state of the market. This calculation helps inform both real estate agents and home buyers/sellers when the best time to put your house on the market is, or if it is finally time to put an offer on your dream home. It also tells us the speed at which the active inventory of available homes is being sold in a time-frame. A large inventory and low amount of homes sold customarily leads to a buyer’s market. While on the contrary, a small inventory with a high amount of homes sold, leads to a seller’s market.
Unfortunately, absorption rate only considers past transactions and therefore will have a small lag in the market. Usually, public databases do not upload the past month’s inventory and homes sold data for upwards of 35 days, so although it is a great parameter to use when making real estate decisions, it might not always be up to date.
How do I Calculate Absorption Rate?
You can calculate absorption rate by taking the number of homes sold in a month and dividing by the inventory of homes available for sale.
Example:
If there are 5000 homes available for sale and there were 1000 homes sold, then there would be an Absorption Rate of 20%. (1000/5000 = .20)
This calculation can also be reversed (5000/1000 = 5.0) to tell us that if no new homes become available for sale, it will take 5 months to run out of current inventory.
This number is most often calculated as a percent. A seller’s market is normally indicated by an absorption rate of 20% or higher. This signals that homes are being sold quickly. A buyer’s market will be expressed by an absorption rate of 15% or lower. A balanced market is produced with an absorption rate between 15-20%. Although this is the most common way for you to calculate absorption rate, there are other ways to calculate absorption rate that use more complex formulas.
What Impact Does Absorption Rate Have on the Market?
The absorption rate is a vital calculation in real estate and is evaluated and used in various ways within the market. For example, an agent might raise the price of his listing if the absorption rate favors a seller’s market. The agent chose to do this because demand for homes in this market is high. On the other hand, when absorption rates are low, this same agent might have to lower the price of his listing in order to get attention from prospective buyers. In general, when deciding whether to buy or sell a home, absorption rate should be considered first in this process. When absorption rates are high, it may be a smart idea to hold off a few months when buying. This will allow for the rate to come back down.
Also, absorption rate can cause an increase or decrease in the need for building new homes. High absorption rates cause an increase in construction of homes and are monitored by construction companies. These corporations factor in absorption rate when projecting year-end or end of month sales.
Lastly, it is a common practice for appraisers to factor in absorption rate when deciding the value of a home. Often it is required for some form of absorption rate to be used within the appraisal process. Appraisers may even calculate the absorption rate for a specific neighborhood. This would allow them to get a more in depth understanding of the true value of a home.
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In Conclusion
Ø Absorption rate provides a distinct understanding of the current state of the market.
Ø It is calculated by taking the number of homes sold in a month and dividing by the inventory of homes available for sale.
Ø This is a vital calculation in real estate and is evaluated and used in various ways within the market.