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Absorption Rate

The rate at which homes sell in an area over a time period

What is Absorption Rate?

Absorption rate, a term commonly used in real estate, is the rate at which homes sell in an area over a time period. An absorption rate greater than 20% is associated with a seller’s market while an absorption rate below 15% is associated with a buyer’s market.

 

Absorption Rate

 

Formula for Absorption Rate

The formula for absorption rate is as follows:

 

Absorption Rate - Formula

 

Buyer’s Market Definition

A buyer’s market is a market where supply exceeds demand – the available properties for sale are greater than buyers looking to purchase properties. Therefore, for a house purchaser, a buyer’s market is an ideal time to make a purchase – homes can be bought at a lower cost compared to a seller’s market. In addition, in a buyer’s market, the absorption rate is lower due to the large number of available properties.

For example, a market where 200 properties are listed with five homes being sold per month would show an absorption rate of 5/200 = 2.5%. In such a situation, it would be a buyer’s market – it would take 40 months for all the currently available properties to be sold.

 

Seller’s Market Definition

A seller’s market, the opposite of a buyer’s market, is a market where demand exceeds supply – the available properties for sale are less than buyers looking to purchase properties. Therefore, for a house seller, a seller’s market is an ideal time to make a sale – homes can be sold at a high price compared to a buyer’s market. Therefore, in a seller’s market, the absorption rate is higher due to the large demand.

For example, a market where 200 properties are listed with 50 homes being sold her month would show an absorption rate of 50/200 = 25%. In such a situation, it would be a buyer’s market – it would take four months for all the currently available properties to be sold.

 

Example of Absorption Rate

Tim is looking to relocate to Toronto from Vancouver and therefore has listed his house for sale in the Vancouver market. To try and sell his house as fast as possible, Tim has priced his house at a competitive price point compared to other houses. Tim would like to know approximately how long it would take for him to sell his house. Tim asks you, his real estate agent, to give him an approximate time frame.

As a real estate agent, you decide to look at the number of available houses in the past 12 months and the monthly house sales over the same time period. By doing so, you hope that you can provide a good estimate as to how long it will take for Tim to sell his house.

Over the 12 months, there have been 30,000 houses listed for sale with, on average, 10,000 houses being sold monthly. You determine the absorption rate for the current market as follows:

 

Absorption Rate = 10,000 / 30,000 = 33%

 

With such a high absorption rate, you inform Tim that it is currently a seller’s market and that it would be a good time to sell his house. In addition, you inform Tim that it would take approximately 30,000 / 10,000 = 3 months for all the historically listed properties to be sold.

Thrilled by the news that it is a seller’s market, Tim is confident that he will be able to sell his house within a couple of months.

 

Importance of Absorption Rate

The absorption rate is an important factor for both purchasers and sellers as it indicates how long it would take to sell current inventory that is on the market based on historical sales.

As noted above, the absorption rate can tell you if the market is a seller’s or buyer’s market.

  • In a seller’s market, there is little inventory available on the market and therefore sellers have more pricing power (therefore a higher price on properties).
  • In a buyer’s market, there is a lot of inventory available on the market and therefore buyers have more pricing power (therefore a lower price on properties).

 

For example, in West Side Vancouver, the absorption rate as of July 2017 was determined to be 32%, suggesting a buyer’s market. It would indicate that property prices in West Side Vancouver are going up. It is consistent with existing data, as the median price of houses in Vancouver has been rising steadily.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Asset Class
  • Commercial Real Estate Broker
  • Real Estate Joint Venture
  • Real Estate Investment Trust (REIT)

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