Understanding Absorption Rate And Its Importance In Real Estate
If you are a real estate buyer and have done considerable research on current property market scenario, you might have come across the term ‘absorption rate’. This is a widely used term amongst real estate pundits who are charged with the responsibility of analysing market trends and give a clear picture to real estate investors. But how is it important for real estate buyers? Here is the note-
What is absorption rate?
Absorption Rate is defined as the rate or the time that will be taken to sell the existing stock of homes listed in the specific real estate market. Though it sounds like simple mathematics, it holds great importance for real estate investors and experts to assess how the market is performing. Absorption rate is a tool to predict the future of real estate sales in a particular micro-market. It also governs the price rise and fall in a given time.
How to calculate absorption rate?
In simple words, absorption rate can be calculated by the number of total houses sold in the market in a previous period divided by the months taken to sell them. Here is an example to understand the absorption rate in detail-
Suppose 30,000 homes were sold in past six months in a large urban area. So, now divide 30,000 homes with six months to derive home sales per month. This comes to 5,000 units per month. Now, consider there are 25,000 homes listed on the market. Considering, that the last stock of 30,0000 homes took six months to subside, divide 25,000 with 5,000. The absorption rate so achieved is 5. This means that it would take 5 months to sell off 25,000 homes in the same micro market.
How absorption rate impacts property prices
Absorption rate is instrumental in determining the market activity and home price movement. For instance, consider the absorption rate for any real estate market is consistent at 5 or 6 months. The speeding up of sales can bring the rate to 4.5 months. This can indicate a price rise in future or even in the current time. In short, the absorption rate is an indicator of demand and supply in the market, ultimately guiding the market prices.
Why is absorption rate important?
- Absorption rate is used by real estate brokers to assess the property prices on a regular basis that are listed in the market. It is not always that property prices climb up due to change in absorption rate. There are times when absorption rates can go up to 12 months or even more. In such cases, the listing prices changes and heavy bargaining is expected.
- It can be used to compare the historical performance with the current scenario. If the absorption period is longer than before, it can impact the valuation of the asset as the rate predicts slower sales in times to come.
How homebuyers can use absorption rate
Home buyers can use absorption rate to determine whether their investment can fetch them good returns in future. A buyer should always consider absorption rate of past two years to understand how a particular market has performed and based on this, predict the upcoming time if he/she plans to exit the investment in the next three years. For long-term investors, a careful and regular study of such rates can help him decide when to exit the market and when to hold the investment.