What is absorption rate?
The absorption rate is the rate at which the currently active inventory is turning over– or how fast homes are selling in relation to new listings on the market. It is calculated by taking the current number of available homes, and dividing it by the average number of sales per month.
For example, let’s say that there are 1,000 active listings in a particular city and they are selling at 100 per month. Divide the current number of listings (1000) by the number of sales per month (100). This gives you how many months of homes are in the current inventory. In this case, the supply of homes will be depleted in ten months.
Additional homes are coming onto the market and being sold all the time. The above calculation does not take this into account, so real estate investors should make it a habit to calculate absorption rates on a monthly basis.
How can absorption rates help real estate investors?
Absorption rates can give you an advance indication of market changes. If a market area you have been tracking has had a steady inventory of six to seven months, and over a two month period drops to six months and five months consecutively, then you are seeing a drop in supply. If the drop in supply trend continues, but the demand for homes does not diminish, then you are looking at the possibility of an upward swing on home prices.