Absorption Rate: Measuring And Calculating It For Market Demand
Andrew Dehan3-minute read
January 06, 2022
The real estate world is full of terms that are unfamiliar to many looking to buy a home. There’s a reason terms like these exist. They’re essential to understand when talking about the real estate market.
One of these terms is absorption rate. Here we’ll define what absorption rate is, how it’s used and what it means for you.
What Is Absorption Rate In Real Estate?
Absorption rate is a term used in real estate to describe the speed homes are sold in a specific market in a specific time frame. It’s determined by dividing the number of homes sold by the number of available homes within the time frameA high absorption rate means there’s a high demand for homes and that homes don’t stay on the market for long. A market with an absorption rate at or above 20% is typically called a seller’s market, whereas an absorption rate below 15% signals a buyer’s market.
Understanding Absorption Rate: A Deeper Explanation
Absorption rate affects the housing market in a variety of ways. With a high absorption rate, sellers know their property is likely to sell quickly due to high demand. High demand can also cause the home value to go up.
On the flipside, in markets with low absorption rates, homes can be on the market for months and buyers will have their pick of properties with little competition from other buyers.
How Absorption Rate Is Used
Real estate agents, brokers and other players in the housing industry use absorption rate to make a variety of decisions. Here’s just a few of the ways:
- Strike a right price: Agents and brokers use absorption rates to determine if demand is rising or falling, and where the home price should be set.
- Accurate appraisals: Appraisers use absorption rates to show market demand and add validity to their
- To build or not to build: Contractors and developers use absorption rates to gauge demand for new homes in an area to determine if they should build there.
- Timing investments: Real estate investors consider absorption rate to know whether it’s a good time to buy or sell. A high absorption rate means prices are up, meaning it’s a good time to sell. A low absorption rate may mean it’s a good time to buy.
How To Calculate And Measure Absorption Rate
The formula for absorption rate is simple. You divide the number of homes sold in a time frame by the homes available. How you adjust these variables can have a big impact on the rate. For instance, if you use all homes in a ZIP code versus the homes in a specific neighborhood with specific features, there can be a big difference.
An Example Of Absorption Rate
Here’s a fictional absorption rate calculation:
- Total homes sold in past 30 days: 10
- Total amount of homes on the market: 45
- 10 / 45 = 0.22 or 22% absorption rate.
This 22% reflects that this market is a slight seller’s market. Traditionally, a percentage of 15 – 20% indicates a neutral market. Above 20% means higher demand and that home prices may rise.
The Relationship Between Absorption Rates And Real Estate Markets
As mentioned above, an absorption rate quantifies whether a home is in a buyer’s or seller’s market. With a seller’s market, the market is often described as “hot” – homes aren’t staying on the market for long, leading to a high absorption rate. This high rate leads sellers to raise their prices. Still, if demand is high enough, bidding wars can happen.
In a market with a low absorption rate, sellers may have to lower their home price to attract buyers. This could lead to sellers accepting below market value for their home because the market in the area has slowed and they need to sell.
The Importance Of Absorption Rates
Absorption rates are an important metric for both sellers and buyers. They can indicate how long the home will be on the market by comparing it to the rate which comparable homes are selling.
It also can play into the price of the home. A home in a market with a high absorption rate will command a higher price than the same home in a market with a low absorption rate.
The Bottom Line: Absorption Rate Measures How Quickly Houses Are Sold
Put simply, the absorption rate is a measure of supply and demand. By taking the number of homes sold in a month and dividing it by the number on the market, you can find a percentage that determines how quickly homes sell. Rates over 20% indicate a hotter real estate market with rising home demand and home prices.
Absorption rate is just one way real estate professionals gauge housing market conditions. Read this article to learn more about 2021 housing predictions and forecasts.
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