What is Absorption Rate?
The absorption rate is the proportion of properties sold in a specific period relative to the available properties for sale in the market.
The absorption rate is the proportion of properties sold in a specific period relative to the available properties for sale in the market. It is a tool used to measure the rate at which properties are sold in a given market over a given period. Based on the absorption rate, one can deduce whether the market is a seller's or buyer's market.
The absorption rate is important for both buyers and sellers to make timely decisions on the price to set for their properties, given the competitive market conditions.
Read also: Understanding IRR, Cash yield and equity multiple
Absorption rate formula
The absorption rate is calculated by dividing the number of properties sold over a specific time frame by the total number of properties available for sale in the market during the same period, expressed as a percentage.
E.g. A total of 1,000 properties were available for sale and 700 of them were sold within the same month. The absorption rate of 70%, calculated as follows:
However, it is important to note that calculation of the absorption rate may vary according to the parameter set for the market and the timeframe used in the measurement.
Effect of absorption rate on the real estate market
The absorption rate can be used as an indication to increase the real estate development of a city. A high absorption rate could mean a high demand for properties during a given period, as the supply of available properties in the market decreases rapidly. This could be a signal for developers to continue building. On the other hand, during a period with low absorption rate, developers could cut down on their construction as there would be already sufficient properties in the market for sale.
Additionally, the absorption rate may aid in the suggestion of suitable pricing for a property in a given market at a specific period. A market with a low absorption rate could indicate a cold market where buyers have more property options to choose from since there are more properties available for sale in the market than the number of buyers. As a result, sellers may set a lower pricing for their properties to attract buyers when the market is cold, and vice versa.
Read also: How does internal rate of return (IRR) impact real estate investors' decision-making process?
What is a good absorption rate?
Depending on the position of an individual, the value of a good absorption rate may differ.
Generally, from a seller’s perspective, a market condition with an absorption rate above 20% is considered good as buyer's demand is considerably high, resulting in a faster sale and a higher price set for the properties in the market. This may also indicate that it is a seller's market.
Conversely, from a buyer’s perspective, a market condition with an absorption rate below 15% is considered good as demand for properties is not as high, resulting in a slower sale and potentially lower property prices. It may also be considered a buyer's market.
In general, the absorption rate is critical to real estate investors as it is one of the key factors to assist them in deciding on their strategy. For example, an investor had taken a longer time than expected to flip his property. He remains unsure whether the property market is still a seller's market given the ever-changing character of the market condition. He recalculates the absorption rate, which has increased from the original 21% to 25%. This increase in value boosts his confidence when setting a higher price for that property.
Limitation of absorption rate
The absorption rate only provides an estimated figure based on currently available data. It does not account for any additional properties that might enter the market during various stages. Real estate professionals would have to consider other factors when assessing market conditions.
Read also: What is loan-to-cost (LTC) ratio?
Read also: What is debt-to-equity (D/E) ratio and what is it used for?
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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.