What Is Absorption Rate?

Absorption rate is a term most commonly used in the real estate market to evaluate the rate at which available homes are sold in a specific market during a given time period. It is calculated by dividing the average number of sales per month by the total number of available homes. This equation can also be reversed to identify the number of months it would take for supply to be sold.

A variation of absorption rates may also be used in corporate finance to allocate costs. In this case, a controller might seek to identify costs based on usage. An accounting absorption rate could be achieved by dividing costs by a specific variable, such as machinery hours, to identify an hourly absorption rate cost.

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Absorption Rate

Understanding Absorption Rate

In the real estate market, an absorption rate provides insight on the rate at which houses are selling. An absorption rate does not take into account additional homes that enter the market at various times since it only provides a figure based on the currently available data. A high absorption rate may indicate that the supply of available homes will shrink rapidly, increasing the odds that a homeowner will sell a piece of property in a shorter period of time. Traditionally, an absorption rate above 20% has signaled a seller's market in which homes are sold quickly. An absorption rate below 15% is an indicator of a buyer's market in which homes are not being sold as fast.

Influence in the Real Estate Market

[Real estate professionals, such as brokers, use the absorption rate in pricing homes.]

For example, in market conditions with low absorption rates, a real estate agent may be forced to reduce a listing price to entice a sale. Alternatively, if recognizing the market has a high absorption rate, the agent can increase the price without potentially sacrificing demand for the home. The absorption rate is also important for buyers and sellers to follow as they make decisions on the timing of purchases and sales.

Additionally, the absorption rate can be a signal for developers to start building new homes. During market conditions with a high absorption rate, demand may be high enough to warrant the further development of properties. Meanwhile, periods with lower absorption rates indicate a cooling period for construction.

Finally, appraisers utilize the absorption rate when determining the value of a property. Some appraisal procedures require an addendum showing that absorption rates were considered in appraisal calculations. In general, appraisers are responsible for analyzing market conditions and maintaining an awareness of absorption rates for all types of appraisal values. Most appraisers include this data metric in the Neighborhood section of appraisal forms. Overall, the current valuation of a home would be reduced during periods of reduced absorption rates and increased when absorption rates are high.

Example of Absorption Rate

Suppose a city has 1,000 homes currently on the market to be sold. If buyers snap up 100 homes per month, the supply of homes will be exhausted in 10 months (1,000 homes divided by 100 homes sold/month). Alternatively, if 100 homes are purchased from the baseline of 1,000 homes, the absorption rate is 10% (100 homes sold per month divided by 1,000 homes available for sale).

Key Takeaways

  • Absorption rate is a term most commonly used in the real estate market.
  • The absorption rate is known for evaluating the rate at which available homes are sold in a specific market during a given time period.
  • Traditionally, an absorption rate above 20% has signaled a seller's market in which homes are sold quickly. An absorption rate below 15% is an indicator of a buyer's market in which homes are not being sold as fast.