When trying to measure the level of demand in a housing market, real estate professionals use the absorption rate.
What Is the Absorption Rate in Real Estate?
If you’ve heard this term being thrown around in the real estate investing industry, it’s important to not confuse it with the absorption rate in finance and accounting. While in that sense it’s used to allocate costs, in this industry, the absorption rate is used to measure real estate demand.
It basically tells us how long it takes for houses to sell in a certain real estate market. Real estate investors use the absorption rate to find out how many months it takes for-sale properties to get off the market. This is an important measurement to understand as it provides some insight into how hot or cool a market is. Thankfully, the calculation for this rate isn’t too difficult.
How to Calculate Absorption Rate
The absorption rate formula is quite simple. In real estate, this rate is found by taking the total number of sold homes in the housing market and dividing it by the total number of available homes for sale. The result is the rate of absorption. This number shows the rate at which all of the current properties on the market are being sold.
For example, if a real estate market had 30 active listings, and 10 of those properties were sold during the month, the absorption rate would be 10/30 = 33%.
You can flip the formula and it’ll tell you the number of months it takes for the complete supply of active listings to be sold In this example, it would be 30/10 which is 3 months.
What Is a Good Absorption Rate in Real Estate?
A good absorption rate depends on what your position in the real estate market is. Are you selling or buying? After all, you want to find the right real estate market to invest in- one where you have an advantage. Asking what is the rate of absorption will let you know where you stand in the real estate market. Let’s first understand what the absorption rate tells us about market conditions:
- A Seller’s Market: This market indicates that current conditions benefit the seller. Buyer demand is higher than the supply of active listings in the market so houses on the market are sold very quickly. Typically, high absorption rates, anything above 20 percent, mean we’re looking at a seller’s market in which properties sell fast.
- A Buyer’s Market: This market indicates that current conditions benefit the buyer. The supply of active listings on the market is high and the number of those listings actually sold is low because buyer demand isn’t as high. Usually, low absorption rates, below 15 percent, signal a buyer’s market in which properties take a bit longer to sell.
What This Means for Sellers
If you want to sell your property and get a good deal for it, you’ll want to wait for a seller’s market. The absorption rate is actually a metric mainly used by sellers or brokers who are trying to figure out the state of a real estate market to price the property accordingly. When the formula is switched to find the number of months it takes for homes to sell in a market, a seller’s market will have a low rate. Typically, anything ranging from 0 to 5 months is indicative of a seller’s market because this means all active listings will sell in a short period of time.
Usually, you’ll find absorption rates above 20 percent and below 5 months in the spring season as this is when buyer demand is at its highest and supply can’t keep up. So sellers should make sure to keep track of their local market’s absorption rate so as to list their homes at a strategic time. If the absorption rates aren’t signaling a seller’s market, you might want to wait until the real estate market heats up.
What This Means for Buyers
Buyers can use this measure to determine what their chances are at getting a good deal when investing in real estate. Like we mentioned above, a buyer’s market is one with an absorption rate below 15 percent. When switching the formula to get the amount of time it takes to sell all active listings in a buyer’s market, buyers will be looking at anything more than 6 months. This means real estate properties are on the market for longer and interested buyers don’t need to worry about extreme competition as there are plenty of active listings.
If buyers find themselves in a seller’s market where the absorption rate is above 20 percent, they should try to beat out other buyers by studying the real estate market well and keeping track of listings. Get pre-approved for a mortgage and have a clear strategy so you’ll be ready to buy.
Are There Any Other Uses?
While it is used by buyers and sellers for making real estate decisions, it also influences other things. Here are some other ways the absorption rate affects the real estate market:
- Real estate agents facing low absorption markets may have to reduce the listing price to attract a cash buyer and close the sale. When facing high absorption markets, agents can up the asking price without turning buyers away.
- Market absorption rates can also affect bank appraisals. Appraisers for home loans will use the market absorption rate as a reason for the property’s selling price.
- Construction and new developments might be a good idea in historically high absorption markets, as this triggers a demand for new housing on the market.
So the absorption rate of a real estate market is used by all types of real estate professionals. It seems to be a measure for different things, depending on what type of decision you’re trying to make. For real estate investors, this is just one factor to consider. If you want to ensure a smart investment in any market, use other real estate market analysis metrics. Mashvisor provides you with all the data you need to make the smartest investment decisions. Learn more about our product.
Originally published at https://www.mashvisor.com on August 18, 2019.