What is "Absorption Rate" and why its important to both Buyers and Sellers

I've written a lot about absorption rates for various Towns and it occurred to me that I've never explained fully what "absorption rate" is and why it is important. Absorption rate in it's simplest form is how long it will take the market you are looking in to absorb the current inventory that is for sale.

In almost all instances, Realtors agree that an absorption rate of 6 months or more is a Buyer's Market and if the rate is below 6 months you are in a Seller's Market. How do we determine what the rate is, the formula used is simple, but if used incorrectly can slant results greatly. The formula used takes the previous 12 months of closed sales (homes that have sold) in the price range you are looking at and divides this number by 12 (the number of months in the year). An example would be if I was looking for the absorption rate for properties between $100,000 to $300,000, I would look back at the past 12 months of homes that have sold in that range. Lets say July 1, 2008 to June 30, 2009 is my range and I found that 100 homes had sold, the per month sold total would be 8.3 houses sold per month.

Now that I know how many homes sold per month for the previous 12 months, I would then look up how many homes are currently for sale in the same price range. If there are 96 homes for sale in my price range of $100,000 to $300,000, I divide the number of homes on the market  which is 96, by the past years per month sold number of 8.33. The formula would look like this :

96 (homes on the market) divided by 8.33 = 11.52 months

The amount of months it will take for the target market we are looking at ($100,000 to $300,000) is 11.52 months . This would indicate that this market range is solidly in a Buyer's Market, since it would take over 11 months for the market to absorb all the homes that are for sale in that range. A Realtor can narrow or expand the price range, depending on what data they are looking for. I tend to use broad price ranges, because I like to see a Towns overall absorption rate that way I can let my Client know where the Town stands.