Might as well start with the boring definition: "Absorption rate is the rate at which homes sell in a given area during a given time period. Absorption rate is calculated by dividing the number of sales in a given month by the number of available homes for sale. It is the inverse of months of supply."
If we were talking about building them instead of selling them, it would be how fast they're coming off the assembly line. But, we're talking about how fast homes are selling, and the absorption rate can give you a jump on market changes. Like any calculation that helps to invest, it's not a slam dunk, but it can help.
For our example to help you to understand absorption rate in home sales, we'll use a three-month period to gather sold data. You can get this from a real estate agent or other source that gives the total number of closings for the period. We'll say that our check finds that in the previous three months 1800 homes sold in our market.
We only have one other number to get to work this calculation, the number of homes currently listed. Again, if you can't get it on your own, get the number from a real estate agent. In our example, we have 3600 homes currently listed. Now we do the simple calculation to get the current absorption rate.
Divide the number of sales over 3 months by 3 to get one month's average sales.
1800 / 3 = 600 homes sold per month on average
Divide the current listing number by our average sold per month.
3600 / 600/month = 6 months
What we find is that at the current rate of 600 homes per month being sold, it would take 6 months to get rid of all of our inventory if no more homes were listed.
Is there a "normal" absorption rate? Real estate is local we know. So, each local market will tend to exhibit what is normal for that market. Higher priced homes generally sell slower, as well as vacation homes. So, in those type markets, we may see absorption taking 6 months to 10 months or longer.
In starter homes and lower priced markets, sales tend to be faster, so you may see average absorption in the 3-month to 6-month range. To get the value from using the local absorption rate in making decisions, you need to keep up with the rate over time. It is changes you're looking for.
Back to our example, let's say that we've been watching the absorption rate for a while, and it is normally running between 5 and 7 months, as it is in our calculation. It's pretty much a normal market right now.
But, we do it again next month, of course our three months will change to the closest three, and suddenly we see that it has dropped to 4 months. In other words, we're selling off inventory faster for one of two reasons:
- Our inventory dropped, meaning fewer homes being listed on the market, OR
- Buying pressure increased, more homes going under contract than normally.
If we've been running this 5-7 month number for a while, this could be a hint of price increases to come. When sales pick up, often prices follow. We just see the change earlier than many because we're watching the absorption rate.
Going the other way, if we see a change this month to 8 months, it could mean the market is slowing down, either too many homes being listed or too few buyers. Either way, the slowing market may signal lower prices on the way.
If you're thinking of listing your home for sale, you'd rather see the first situation, a change to a faster absorption rate, as you hopefully can expect to get a higher price. A buyer may want to adjust any offers they plan on making a little lower than they would have made them to see if they can grab a bargain.
Put absorption rate into your toolbox for more market knowledge and better decisions.
Have you found success in real estate investing by implementing different approaches? Have you struggled to take that first step? Let me know what you think by leaving a comment below, or by finding me on social media: