Real Estate Absorption Rate and What it Means for Investors
Everyone knows that the real estate market is ever-changing. And being able to predict market fluctuations accurately is like chasing a moving target. There are endless ways of taking the real estate market’s temperature — here’s just a few to give you an idea: inventory, neighborhood comps, median sale prices, number of days on the market, local economic indicators. Having to make these calculations over and over again can get exhausting for real estate professionals, leaving them wishing for one reliable way of gauging any given market. However, that would be too good to be true – but is it? Enter the absorption rate in real estate, a simple yet powerful calculation that’ll leave you feeling very grateful.
What is Absorption Rate?
Absorption rate is a measurement of how slowly or quickly homes are being sold, in any given market over any given period of time. Because the real estate absorption rate is a good indicator or how quickly homes are being moved off the market, many real estate professionals use it to determine whether it’s a buyer’s or seller’s market and whether the market is hot or cold. In addition, it can help sellers price their properties competitively, given the market conditions. This simple little calculation proves itself to be quite a powerful tool.
How to Calculate Real Estate Absorption Rate?
To calculate the absorption rate, you’ll first need to know the formula. The absorption rate formula is the number of properties available for sale in a given market, divided by the number of properties sold in a given period of time.
Absorption rate calculations will vary, as it’s up to you to set the parameters for the market and period of time you’d like to measure. For the purpose of this example, however, let us define the market as “X” neighborhood, and the timeframe as one month:
- Identify active listings: In “X” neighborhood, there were 5,000 active listings on the market last month.
- Identify sold listings: Within the month, 1,150 of these listings were sold.
- Find the percent of listings sold out of active listings: The absorption rate of “X” neighborhood was 23 percent. (1,150 listings sold out of 5,000 active listings = 23 percent.)
In this example above, the absorption rate in the given “X” neighborhood market was 23 percent. However, keep in mind that real estate professionals will set their own parameters for the calculations, such as the size of the market they want to measure, and the length of time. When looking at the rate that someone else calculated, be sure to consider the parameters used. The nice thing about this formula is that it’s flexible in nature, and you can use it in a way that’s helpful to you. At this point, the rate 23 percent may not mean anything to you. In the next section, we’ll discuss what these rates mean, and what constitutes a “good” or “bad” absorption rate.
How To Find Absorption Rates For Apartments
Absorption rates for apartments typically rely on leasing information from a specific time period. They can be used to compare different time periods, or to compare rental rates of a property. These comparisons can typically reveal market trends in the area including rental demand. Real estate professionals of all types can use this information when analyzing a multifamily rental unit.
Here is a walk through to help you find the absorption rate for apartments:
- Add up the total number of units: In the building there are 7 apartment units total.
- Set a time period for analysis: We will look at a 3 month period.
- Calculate the number of units rented: Between October and December, 5 units were rented.
- Divide by the total number of units: 5 / 7 = .71
Based on this example, the absorption rate from October to December was roughly 71 percent.
What is a “Good” Absorption Rate in Real Estate?
In the example above, we calculated that the absorption rate in “X” neighborhood last month was 23 percent. As an industry rule of thumb, anything over 20 percent is thought of as a good absorption rate in real estate. It signals a strong seller’s market, in which properties are moved off the market quickly. Learn how to take advantage of a seller’s market so you never miss out again. Anything below 15 percent is thought of as a slow absorption rate—a buyer’s market.
As a real estate investor, this type of indicator is critical. The absorption rate of a given market will be the key to helping you decide on your strategy. For example, let’s say that you are set on investing in a certain real estate market, but you’re not sure what to do yet. You calculate the absorption rate, and it’s below 15 percent. Of course you’ll go on to perform further research and analysis, but at first glance, the rate helps you decide on a buy-and-hold strategy. On the contrary, let’s say that you’ve just finished flipping a property that unexpectedly took you longer than originally planned, and you have no idea if your original neighborhood comps still hold up. You do a quick calculation and are pleasantly surprised to find that the absorption rate increased to 25 percent. This information helps you feel confident when you place a higher price tag on that property.
The Importance Of Real Estate Absorption Rates
Real estate absorption rates can be used by a variety of real estate professionals, from investors and lenders, to buyers and sellers. The purpose of these figures is to compare properties to others on the market. This analysis can suggest which properties will sell for more, or which areas have higher demand than others. In apartment buildings, the absorption rate can help you analyze periods of higher demand. In real estate, there are numerous tools at your disposal for analyzing properties. Absorption rate is one more addition, aimed to help you review potential options and make better investments.
It can’t be stressed enough how powerful of a tool being able to calculate the absorption rate in real estate can be. At one glance, it’ll help you catch the pulse on any given market: Is it hot or cold? Is it a buyer’s or seller’s market? What is an appropriate strategy? Of course, like in any given scenario, you’ll want to do your due diligence and run a full analysis before making any decision. However, if you’ve been aching for a simple way to quickly take a market’s temperature, give the absorption rate a try and you’ll be pleasantly surprised.
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