Absorption Rate in Real Estate and what does it means for you?
In the real estate industry, the absorption rate is used to measure the demand of real estate.
The absorption rate basically helps us determine how long it takes for houses to sell in a specific area. This could be a city or town, a neighborhood or an area like our Wachusett Area. Real estate agents and Realtors use the absorption rate to find out how many months it takes for current homes that are for sale to sell. Whether you are a seller, buyer or an agent, its important to understand this as it provides some insight on how the real estate market is. The good thing about this is it doesn’t take a degree in math to understand how to come up with this figure. Lets see how its done.
How do we calculate the Absorption Rate
To calculate the absorption rate formula is pretty easy. In our industry, the rate is found by taking the number of sold homes in a specific area during a specific time-frame and dividing it by the total number of homes currently for sale. The result we get is called the absorption rate . What this figure tells us is the rate at which all of the current homes for sale are being sold.
Lets look at our very own town of Rutland for example; As of today, Rutland has 15 active single family homes for sale. Over the past 30 days, 6 homes have sold. The absorption rate for Rutland right now would be 6/15 = 40%
If we reverse this formula, it will actually show us the number of months it takes for the current supply of active listings to be sold. In our example above, it would be 15/6 which is about 2 1/2 months. This tells us that if no other houses came on the market, that based on supply and demand, that it would take only 2 1/2 months to sell all the current inventory. Now this may not seem like a big deal but when looking at the number of buyers looking for homes vs the actual number of homes available, we see that there is huge demand for houses right now
How does the Absorption Rate help us determine a seller’s or buyer’s market?
If you are considering buying or selling a home in a specific area, its always good to know what the absorption rate is in that area. A knowledgeable Realtor will be able to provide insight on the actual numbers. The absorption rate is going to let you know whether this area is good market to buy or a good market to sell. What’s the difference between these markets?
- A Seller’s Market: This market tells us that it benefits the seller. The demand from buyers exceeds the current supply of active listings on the market. When we see this, usually it means that houses are being sold very quickly and most oftentimes for more money. A sellers market is also determined, generally, when the absorption rates are anything above 20 percent.
- A Buyer’s Market: This market tells us that it benefits the buyer. This is when the current supply of active listings on the market exceeds the number of listings actually sold because the demand from buyers isn’t as high. When this occurs, we tend to see houses take longer to sell and oftentimes they sell for less than what the original asking price is. A buyers market is also determined, generally, when the absorption rates are anything below 15 percent.
RELATED ARTICLE: Buying in a Sellers Market
As a Seller, what does this mean for you?
If you are considering selling your home and want to get the most money for it you’ll want to wait for a seller’s market. The absorption rate is one of the figures that is used to determine the current state of the real estate market in order to price the home appropriately. As shown above, when we reverse the calculation to find the number of months it would take for homes to sell in a market, a seller’s market will have a low monthly supply rate. Typically, anything ranging from 0 to 5 months indicates a seller’s market because this means all currently active listings will sell in a relatively short period of time.
Oftentimes, we find absorption rates above 20 percent and below 5 months of supply in the early spring market as this is when the demand of buyers are at its highest and the supply of homes can’t keep up but lately this has been the trend for months and seems to be still trending this way. This is a great reason that sellers should make sure to keep track of their local market’s absorption rate. Or better yet, they should hire an agent who will watch the market for them so that they can advise them in order to list their homes at the most strategic time. If the absorption rate isn’t favoring a seller’s market, you might want to wait until the real estate market heats up.
Right now, we are at an all time historic low with regards to current inventory. This is one of the first times we have ever seen the amount of homes in all of Massachusetts so low. Right now we have almost 25% less single family homes for sale than we did this time last year and almost 50% less than we did back in 2016. This is a clear indication of where the market is trending
As a Buyer, what does this mean for you?
If you are looking to buy in a certain area, this absorption rate is good to determine what the chances are for getting a good deal on a house. As we mentioned earlier, a buyer’s market generally has an absorption rate below 15 percent. When reversing the calculation to get the amount of time it takes to sell all currently active listings, as a buyer, you will want to look at anything over 6 months. This will mean that the houses are on the market for longer and buyers don’t need to be too concerned about a lot of competition as there is plenty of homes to look at. In a buyers market, you have the ability to shop a little longer, see more homes and not be rushed into making quick decisions vs trying to buy in a sellers market where you are likely to be in multiple offers and and need to get out to look at the house moments after its listed or you may miss out.
As we are right now, buyers will find themselves in a seller’s market where the absorption rate is well above 20 percent. Buyers should try to beat out other buyers by working with an agent who studies the real estate market, knows it very well and keeps track of all the listings as they become available so they can get you out first. A buyer should also get pre-approved for a mortgage and have an understanding of the process in order to be well prepared to jump quickly.
RELATED ARTICLE: Pre-qualified vs pre-approved; What you should know
Can the Absorption Rate be used for other uses?
While real estate agents & Realtors use it for buyers and sellers for helping them make good real estate decisions, it also influences other things as well. Here are a few other ways the absorption rate affects the real estate market:
- When sellers and agents are in a low absorption rate market, they may have to reduce the listing price to attract a buyer in order to sell the house. When in high absorption rate markets, sellers and agents may be able to increase the asking price without turning too many buyers away. Ultimately, some buyers will walk away, but there are more buyers that will likely pay the sellers price.
- The absorption rates can also influence bank appraisals. Appraisers sent out to evaluate the home for a mortgage will use the absorption rate in that specific area as an additional reason to justify the property’s selling price.
- The absorption rate can be a sign for new construction builders to start building new homes. During market conditions with a high absorption rate, the buyer demand may be high enough to influence the development of new homes because currently inventory is low and there isn’t many homes to choose from.
If you are considering buyer or selling this year and want to know more about your current market, feel free to contact us for free home and market evaluation