Absorption Rate: What Is It And How To Calculate It

If you’re an investor or just someone looking to sell your own property, understanding certain metrics is key. One of the most important is absorption rate. It helps you understand the overall health of the market and how to measure your progress in relation to other homes selling in the area.

What Is Absorption Rate?

In real estate, absorption rate can be thought of as the rate at which available homes come off the market in a particular area over a given time. Although the time frame can be whatever interval you choose, it’s traditionally been measured on a monthly basis. It’s a measure of inventory turnover.

How To Calculate Absorption Rate

When it comes to calculating absorption rate, you need to start with two pieces of data:

• Number of homes sold over a given time frame
• Number of available listings over the same period

From there, absorption rate is calculated according to the following formula:

• Absorption Rate: 40%
• Number of Homes Sold: 20
• Number of Available Listings: 50

Absorption Rate= 20 ÷ 50 = 0.4

As an example, if there are 50 homes available in a month and 20 sell, 20 ÷ 50 = 0.4. After we multiply by 100 to convert to a percentage, that comes out to 40%.

Interpreting Absorption Rate Data

Absorption rate is just one of many real estate trends you should consider when deciding whether the time is appropriate to buy or sell a house. Others include the average number of days on market in the area as well as the general trend in home prices, particularly when it comes to properties comparable to your own. Here’s how to think about absorption rate:

• A high absorption rate indicates a seller’s market: A high absorption rate means properties are flying off the market faster and you can expect more competition for homes. In general, this is considered to be anything over 20%.
• A low absorption rate indicates a buyer’s market: A low absorption rate would be anything under 15%. This indicates a buyer’s market where there might be more room to negotiate the price down.
• A balanced absorption rate indicates market equilibrium: There is a state in which the market favors neither buyers nor sellers. This balance point occurs when the absorption rate is between 15% – 20%.

Why Is Absorption Rate Important?

Whether you’re looking to renovate and flip properties or just buy a home of your own, understanding the real estate absorption rate can be very important because it’s one metric you can use to determine supply and demand. Along with the average days on market, it allows you to determine the health of the market and leverage on either side of the transaction.

For Sellers

If you were in the middle the home selling process, knowing the absorption rate could help give you an idea of how to structure your bid contest. If your calculations give you an idea that it’s a tight market, you might set the conditions for a bidding war. You can accept offers while notifying others who have previously offered to give them a chance to beat the competition.

Alternatively, if the market isn’t as hot or you’ve been accepting bids for a while and just want to get things over with, you might ask for the person’s highest and best offer. If the market is really cool and favors buyers, you may wish to hold onto the property for a while longer or be prepared to negotiate on certain considerations.

For Buyers

Buyers need to be aware of the absorption rate because it gives a fairly good idea of how much competition you can expect to face bidding for property. If homes are selling quickly, you may wish to take that into account and come out of the gate with your best offer. If they aren’t, you may have more room to negotiate.

It’s important to note that going back and forth may or may not work in the home buying process. It all comes down to whether the home is priced right in the first place. If it is, you’re better off just putting your best foot forward to begin with rather than playing hardball. A good real estate agent will be able to help you determine whether the price is in line with the market.

Factors That Influence Absorption Rates In Real Estate

To this point, we’ve discussed the importance of the absorption rate and how to interpret it, but we haven’t touched on the factors that actually influence what happens.

Market Conditions

There are several market factors that impact absorption rate:

• Buyer demand: Simply put, if buyer demand is higher, homes are going to sell faster. This drives up the absorption rate. The opposite happens if the market is cool.
• Economic factors: Economic factors including the labor market in the area and the cost of living also play an important role in demand and absorption rate.
• Interest rates: If interest rates are low and financing is cheap, absorption rate may adjust proportionally higher, with the pendulum swinging the other way in a rising rate environment. Given that, if you have to sell, your idea of what constitutes a hot or cold market may adjust by a percentage point or two depending on where interest rates sit.
• Sale prices: This is very short-term market dependent, but the idea is that when a market is about to flip toward buyers, sellers are usually behind on lowering prices by a month or two because the natural inclination is to get as much for your house as you can. So, in the intervening time when there is a mismatch between sale price and worth, absorption rate can go up.

Inventory Levels

Inventory levels are measured based on the number of months it would take to sell out of the active listings on the market at the current sales pace. If inventory is low, that’s an indication that the absorption rate is going to run higher. If it’s on the high side, it’s going to run lower. For reference, a market is generally considered in balance if there’s 6 months’ worth of inventory.

Seasonal Changes

You should also expect some variation in the absorption rate based on the time of year. In most markets, the hottest time for property sales is late spring or early summer because people want to get moved before school starts for their children. However, it may be different if you live in a tourist area like Vail, Colorado, where skiing and other winter sports are a big attraction.

If there is a time when people tend to move in your area, that’s when the absorption rate will be higher versus slower seasons.

FAQs: Absorption Rate

Before we close, let’s answer a few more questions that may be on your mind.

What is the significance of the rate of absorption?

The rate of absorption tells you how quickly properties are selling in the market over a time horizon of your choosing. It’s a good way to know how much demand there is in the market.

What is an average absorption rate?

Generally, anywhere between 15 – 20 days is considered an average absorption rate. If you get lower or higher than that, it’s an indicator that you can be in a particularly hot or cold market.

What does a low absorption rate mean in real estate?

When there’s a low absorption rate, it means that demand is lower relative to the amount of inventory available on the market. It can be an indicator that there might be leverage for buyers in negotiations.

The Bottom Line: Understanding Absorption Rate Can Be Beneficial To You

Absorption rate is the percentage of active listings that sold within a market compared to the total available inventory. It’s a key real estate trend to make sure you understand because buyer’s markets tend to have a lower absorption rate while absorption rates are higher in seller’s markets.

If you’re not sure about any of this, having an experienced real estate agent to guide you through is the way to go. If you’re ready to get started, we can connect you with one of our Partner Agents.