Using the Absorption Rate in Real Estate to Measure Demand
How this Calculation Determines a Buyer's vs. Seller's Market
The housing market is still working in favor of home sellers these days. In fact, median existing home prices are up nearly 5 percent year over year, according to the latest existing home sales data from the National Association of Realtors, and housing inventory remains low, which keeps demand high.
“Too many would-be buyers are either being priced out, or are deciding to postpone their search until more homes in their price range come onto the market,” Lawrence Yun, NAR's chief economist, says in a statement.
But there's another way to measure demand—by calculating a housing market's absorption rate.
What's the 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, such as over the period of a month. The rate is calculated by taking the number of homes sold in the given time frame—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, according to Redfin.
Let's assume 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 percent, which is the rate you get when you divide 250 by 1,000.
To give another example, 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 percent—50 divided by 2,000.
Housing markets with an absorption rate that equals more than 20 percent are considered to be seller's markets. On the other hand, those markets with an absorption rate lower than 15 percent indicate buyer's markets, according to Investopedia.
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.
How is the 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 that Affect Real Estate 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 homebuying goal. For example, the Federal Reserve is expected to raise the federal funds rate two more times before the end of 2018, which indirectly affects mortgage rates.
As of late August 2018, the 30-year fixed-rate mortgage averaged 4.52 percent, which is drastically higher than the 3.82 percent average during the same period a year ago, according to Freddie Mac's Primary Mortgage Market Survey.
Demographics can also affect real estate demand, as well as changes in government legislation and tax incentives, Investopedia says.