In real estate, an absorption rate is a measure of supply that calculates the rate at which the supply of properties in a specific market are sold. It is essentially a method of calculating the amount of time it could take to sell units that are currently on the market. Absorption rate can be used as a tool that helps both buyers and sellers better understand the happenings of the real estate market.
When determining the price of their own property, many sellers base the decision on market value of homes in their neighborhood. While effective in some cases, this approach does not give an indication of approximately how many other properties are up for sale at the same time. Absorption rate offers a way to see what is occurring on the market, and helps the seller understand what they are up against.
Absorption rate can also provide a buyer with the opportunity to negotiate lower prices on inventory they may have in the market. Based on the supply and demand theory of basic economics, if the demand is consistent, an increased supply usually results in lower prices to restore the balance of the market. Likewise, if supply is limited, buyers typically pay more to obtain the items for sale.
For the most part, absorption depends on the property sales in a particular area, and how well a specific property compares with the demand in that location. Developers often take a look at the overall demand for new homes and how their properties fare in comparison to the local supply. This allows them to determine the absorption rate, and ultimately their ability to sell new property in that area.
Here is an example of the absorption rate formula: let’s say a given area sells an average of 1,000 new homes per year, and the development company gains 2% of the market there. In this scenario, their rate of absorption would be 20 properties per year. At this point, there are only two ways that rate can change — from a change in the number of homes sold, or due to the sudden shift in competitiveness of the property against local inventory.
Absorption rate can prove to be a viable method for analyzing market trends over time. This is because, similar to other industries, the real estate market is primarily one of supply and demand. Some consider absorption rate as merely a guide. Others, however, view it as a valuable tool that can help buyers and sellers obtain a clear vision of market and, thus, make more informed decisions in regard to property.
