The housing market is still working in favor of home-sellers these days. In fact, the latest numbers from the National Association of Realtors indicate that existing home sales are up 6.5%, indicating continuing high demand for homes.
But there's another way to measure demand: by calculating a housing market's absorption rate.
- The absorption rate compares the number of homes sold in a given period to the total number of homes on the market.
- An absorption rate of more than 20% is considered a seller's market, while a rate of less than 15% is considered a buyer's market.
- Those who work in the housing industry, such as realtors and homebuilders, will use the absorption rate to help determine their focus, outlook, and pricing.
What Is Absorption Rate?
The absorption rate is defined as the rate at which homes that are available in a particular market are sold over a specific time frame. The rate is calculated by taking the number of homes sold within a period—say, over 30 days—and dividing that number by the total number of available homes in the market.
If there are two different price ranges in a particular housing market, you should focus on calculating the absorption rate for homes in your price range.
Let's assume that in a hypothetical housing market, there are 1,000 homes available for sale. Since we're in a seller's market, 250 of those homes quickly sold in just a month's time. The absorption rate in this market is 25%, which is the rate you get when you divide 250 by 1,000.
To give another example, say there's a housing market with 2,000 homes available for sale but only 50 homes have been sold over the last 30 days. In this case, the absorption rate would be 2.5%—50 divided by 2,000.
Housing markets with an absorption rate that equals more than 20% are considered to be seller's markets. On the other hand, those markets with an absorption rate lower than 15% indicate buyer's markets.
Flipping the equation gives you an idea of how long it would take for a given market to run out of housing inventory. To calculate this, you would divide the total number of available homes by the number of homes sold over the given time frame. Using the first example above, you'd divide 1,000 by 250, which means it would take just four months for that hypothetical housing market to run out of homes for sale.
Absorption Rate Used
Professionals in the housing industry are interested in absorption rates for various reasons. Real estate agents and brokers use it to determine how to price a home for sale. In a seller's market where available homes don’t stay on the market for long, agents and brokers are able to bump up the price since there's an elevated level of competition.
Along with reviewing historic prices against today's prices, appraisers factor in absorption rates when evaluating a home's value. Absorption rates can also serve as a gauge for builders trying to determine whether it makes sense to build more homes or wait it out.
Other Factors Affecting Demand
Changes in mortgage interest rates have the ability to make or break whether a consumer enters the housing market. Economic influences causing rates to jump significantly over the course of a few months could delay someone's home-buying goal. For example, if the Federal Reserve is expected to raise the federal funds rate, this indirectly affects mortgage rates.
As of February 2020, the 30-year fixed-rate mortgage averaged 3.47%, which has been falling consistently for months.
Demographics can also affect real estate demand, as well as changes in government legislation and tax incentives.