Pricing Realistically - Understanding Absorption Rate in Real Estate
Housing economists and experts use the absorption rate in real estate to predict the housing market, while sellers may heard the phrase through the media but really don’t know what absorption rate represents. Since April 2009, appraisers are required to use absorption rate for all government loans.
Absorption rate is an assessment of the current housing inventory, including properties under contract (pending) because a prospective buyer can walk at any time, divided by current rate of sales, expressed in months of supply. In any local real estate market, the absorption rate is generally considered the best indicator of whether the housing is either a seller’s or a buyer’s market.
- Normal Market - Absorption Rate is between 5 and 6 months.
- Sellers Market - Absorption Rate is lower (1-4 months)
- Buyers Market - Absorption Rate is higher (7+ months)
To simply define absorption rate in real estate, it is the number of months it will take to sell all homes for sale. For example a 12 months supply would mean that at the current rate of sales and no additional homes coming on the market, it would take 12 months for the inventory to deplete.
Just like in any industry, supply and demand play an important role. If the demand is slow coupled with increasing supply will give you lower prices that results in a buyer’s market. Likewise, if supply is limited, home buyers will typically pay more for the home - seller’s market.
When it comes to calculating the absorption rate in real estate, it really brings the housing market for sellers and buyers into perspective. For sellers, it will define the market in how to price the home realistically when comparing their competition with the result of a faster sale. For the buyer, the absorption rate can provide a negotiation tool to obtain a lower price.
In reality, there is only a certain number of homes that will sell in any given period. While absorption rate is not an exact science, the key to you selling or buying a home is understanding the local real estate market and trend providing you with a clear vision when it comes to making an informed decision.
Copyright © 2010 By Petra Norris * Pricing Realistically - Understanding Absorption Rate in Real Estate*
Managing Broker - CDV TransAtlantic, Inc.
(863) 619-6918
Petra, My kind of gal! I am an absorption rate nut. You gave us a wonderful explanation of why/how absorption rates are needed and figured. Great post Petra :)
Petra, the guidelines of knowing whether a buyers, or sellers or balanced market does assist the seller in pricing their property based on market conditions.
excellent summary! I've been trying to education potential sellers (and sometimes buyers) about the importance of the absorption rate. I may have to reblog!
Elizabeth - I'm glad that I'm your kind of gal :) I know you are an absorption rate nut. Twice today you commented on my posts - thanks.
Gary - It really doesn't take a lot to show buyers and sellers in what market we are in at this moment :)
Kerry - thanks for the reflag. I hope my article will help your sellers and buyers :)
Petra, very well explained. Absorption rates are an important tool for sellers so they can realistically price their properties in order to meet or even beat the rate.
I write a monthly market report for my area and recently started including the absorption rate. Not only do clients need to know and understand this, but by writing about it, I'm becoming more knowledgeable.
If only that would bring certain sellers to a realistic level on where to price their home....some are oblivious to it...but it is one great educational tool to use at a listing presentation...Thank you Petra and happy holidays!
Sometimes the language is just not enough to make sellers understand that they are tryingto get too high of a price for the house.
Petra,
This is a brilliant blog and I re-blogged it. Sellers really have to understand what is going on in the market to make sure they are priced correctly. It is a complete waste of time to list out of the market trends to "see if you can get a little more". In fact, I'd say that cost sellers as by the time they try to get in line, the prices have dropped and they need to be listed even lower.
All the best, Michelle
Hi Petra. Absorption rate is an important stat for agents to know off the top of their head. Not because folks will ask them but as you pointed out it will help give them a better handle on market conditions.
Active listing inventory divided by average number of monthly sales = absorption rate by months
Well done! Thanks for the refresher!
I also do a market report that shows absorbtion rate. It is interesting how the months' supply can change by going up just a little in price. Great post!
Great explanation. It certainly helps to explain to sellers what they are up against.
Very good post. The home buying and selling public needs to understand this and get an accurate picture of what real estate trends mean in their local markets. The media offers a tremendous amount of negative information these days that discourages sellers and causes buyers to believe they can low ball a seller and get what they want in all cases.
Absorption rates are good information for sellers to take into consideration when selling their homes.
This is why I use absorption rates all of the time and have begun to show actives as readily as solds in my cma's unlike in the past. I also use solds more with buyers to show them that they can ask for these incredible reductions but almost never do they get anywhere near what they ask.
Hi Petra -- I used absorption rates extensively, but find there is little value in a nutshell when it comes to selling one home. The advice given to one seller, regardless of a strong buyers or sellers market, can trump the data. It does help to gauge general demand, but most importantly, its imperative to know what is selling and why, what is not selling and why not, and to help put that seller in a category that is selling. Just my 2c worth.
I know this number for many neighborhoods. Just because it's a good thing to know when you're talking with perspective clients.
Excellent post, and very useful! I will certainly be using this with my sellers
Petra, this was a very good explanation, but I do have a question: are pending sales always used in the formula to determine the absorption rate? Just curious...
Petra - great post, as usual. Can you share how you prepare an absorption rate?
Thanks for a clear, easy to understand explanation of absorption rate.
Great explanation. I've been meaning to keep track of this more closely.
Petra -- great explanation. It's helpful to refer to this information when dealing with sellers.
I have a listing right now where we have 8 others for sale in the development and we're still moving downward.
In our area REO homes sell pretty fast because they are priced so low. Generally they are not the quality of the non-REO homes which are, of course, priced higher. And the market for them is almost at a standstill. So it seems that we have two kinds of absorption rates.
Petra ~ Very well said, important invormation sellers need to understand to price realistically.
Petra,
In my area, we agents use the term absorption rate but I find others often ask about how many months of inventory. Same animal - and important to know, as you say!
Absorption rate can vary from price point--- here in the San Diego community are absorption rate for any home under $350,000 is much higher than homes that are over $950,000. Then many other factors must weight. Being price right, etc.
As they say it much easier to afford a Honda, then a Mercedes.
Thanks Petra. Clear and concise explanation.
Absorption rates are critical when you list a home. It gives sellers a realistic expectation of the market and when I can I drill it down to the neighborhood as some have lower or higher than others.
To everyone - Wow I had not expected this kind of a response. Understanding absorption rates makes us better real estate agents. Knowing where the market is and where it is going is very important in our profession and to our clients and consumers.
#20 William - Yes, I do use the pending in my absorption rate.
#21 Lori - Absorption rate is figured by for example: Let's say you have had 120 sales within the last 12 months and currently there are 150 homes in active/pending. The calculation is: 120/12= 10 150/10= 15 months of supply.
Hella - In my overall market reports I do separate absorption rates for traditional sales and distressed.
Thanks for the reblog to:
Ted Tyrrell
Jim & Linda Arnold
Richard Iarossi
Michelle Francis
Kerry Lucasse
Petra, I can't believe how few, in our industry, don't understand absorption rates and pricing.
This is really, really important to understand. It is not only what your home is worth but what are the odds of selling at the number that you select. I love to look at these stats with Sellers and see the light bulbs go off when they grasp pricing through this lens. The five to ten percent of the Sellers with homes selling in this marketplace grasp the absorption concept.
Absorption rates are critical when determining, price and market saturation. Great Post...
Petra - This is an important concept for consumers to understand. I also agree with the comment above that absorption rate can be different at different price ranges.
Great explanations. I think a lot of people just use 6 months for everything, but with the market the way it is, it is better to break it down.
I always speak to my sellers about the absorption rate for thier home price/ market area. It amazes me at the number of real estate agents who have no clue what that is or how to figure it out. Thanks for sharing!