Definition of Absorption Rate
Absorption rate is the rate at which homes sell in a specific market over a given period of time, usually a month. The absorption rate is calculated by dividing the number of homes that sold over the given period of time by the total number of homes still for sale. If an area contains homes in two different price ranges, you can calculate the absorption rate just for homes in your price range. The higher the absorption rate, the faster homes are selling.
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.
Understanding the Absorption Rate
In the real estate market, the absorption rate provides insight into how quickly or slowly houses are selling. An absorption rate does not take into account additional homes that enter the market at various times since it only provides a figure based on the current available data. A high absorption rate may indicate that the supply of available homes will shrink rapidly, indicating that a homeowner will sell a piece of property in a shorter period of time. Traditionally, an absorption rate above 20% has signaled a seller’s market in which homes are sold quickly. An absorption rate below 15% is an indicator of a buyer’s market in which homes are not being sold as fast.
Absorption Rate Used
Professionals in the housing industry are interested in absorption rates for various reasons. Real estate agents and brokers use it to determine how to price a home for sale. In a seller’s market where available homes don’t stay on the market for long, agents and brokers are able to bump up the price since there’s an elevated level of competition.
Along with reviewing historic prices against today’s prices, appraisers factor in absorption rates when evaluating a home’s value. Absorption rates can also serve as a gauge for builders trying to determine whether it makes sense to build more homes or wait it out.
The real estate broker or agent is interested in absorption rate because they’re tasked on a regular basis to value properties to be listed for sale. When they’re sitting in front of a listing client, they want to make them happy and tell them that the home is worth every dollar the owner wants to get. In many cases that isn’t the case, and it’s hard to tell them that they must list it for a lower price and be prepared to bargain on that.
One of the tools they use is the absorption rate. They can show the homeowner that the current absorption rate has slowed, and use that information to justify lowering the listing price. On the other side, if the rate has increased, they may be able to list for more than they anticipated, as there is good demand and a smaller supply. Of course, this changes almost daily, but we must use some measure to help in decision-making.
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.
Can the Absorption Rate be Used for Other Uses?
While real estate agents & Realtors use it for buyers and sellers for helping them make good real estate decisions, it also influences other things as well. Here are a few other ways the absorption rate affects the real estate market:
- When sellers and agents are in a low absorption rate market, they may have to reduce the listing price to attract a buyer in order to sell the house. When in high absorption rate markets, sellers and agents may be able to increase the asking price without turning too many buyers away. Ultimately, some buyers will walk away, but there are more buyers that will likely pay the sellers price.
- The absorption rates can also influence bank appraisals. Appraisers sent out to evaluate the home for a mortgage will use the absorption rate in that specific area as an additional reason to justify the property’s selling price.
- The absorption rate can be a sign for new construction builders to start building new homes. During market conditions with a high absorption rate, the buyer demand may be high enough to influence the development of new homes because currently inventory is low and there isn’t many homes to choose from.
Market absorption rate is an important real estate term that both buyers and sellers should be aware of. As you can see from the above information, the market absorption rate can impact the buying and selling experience.
If you’re thinking of buying a home, knowing what the market absorption rate is can help you better understand what you’ll be up against. Knowing whether or not you should request seller concessions or home warranties in your offer is important.
If you’re thinking of selling a home, knowing the absorption rate can help you hone in on a specific time to list your home for sale. In addition, it can help you understand whether you will likely be seeing a large amount of buyers inquiring on your home or not.