Absorption Rate? What is this about?

By
Real Estate Agent with Century 21 Results Realty

There are some terms that we toss around in the real estate industry as if people knew what we were talking about...  Absorption Rate is one of those terms. 

It isn't complicated, but if you are unfamiliar with the term, if can be confusing.  And unlike "Bacon Double Cheeseburger", it isn't really self explanatory. 

What is Absorption Rate?

There are a couple of components to Absorption Rates

  • Inventory Level
  • Sales Pace over a specified time period
  • How long the inventory would take to be "used up" at the current level and pace...

That is it in a nutshell.  But, let's look at a few examples, as well as some caveats.  By the way, this isn't just for real estate, but can apply to anything that might be considered a commodity... 

Let's say that your family eats frozen pizza twice a week, and you have 6 Digiorno's Pizzas in the freezer.  If you don't go to the store to pick up more, and you continue eating them at the same pace, you have a three week supply of frozen pizza

Obviously there are a couple of ways that you can alter that situation. 

  • You can start with more pizza
  • You can alter how often the family eats pizza

Now, maybe you buy your pizzas at Costco, and go there once a month...  Even though you have 6 pizzas in the freezer, if you aren't going to be going there for another month, you might want to pick up a few more.  If you buy 3 more pizzas, you will have a 4 1/2 week supply, which will carry you through another month. 

About that "Specified Time Period"

In order to quantify sales or usage pace, we need to look at a period of time.  Back to our pizza... 

With Thanksgiving happening recently, the fridge is full of turkey, so maybe in the last week we haven't had any pizza...  But, things were really busy before that, so we had 3 pizzas in 6 days.  So, if we look at just the last week, we had 0 pizza... theoretically, 6 pizzas would last forever.  That can't be right.

So, we look at a longer time period.  Over two weeks we had 3 pizzas... 1.5/week.  That means that the 6 pizzas would last 4 weeks. 

But wait...  If we look at the last 4 weeks we had 8 pizzas... that is where we came up with the 2/week consumption level.

 

How about in Housing?

The generally accepted number in housing for inventory level is 6 months.  That means that is 100 homes are selling each month in a given area, then having around 600 homes on the market would be fairly balanced. 

If there are only 200 homes on the market, sellers have the upper hand.  Basically, supply is smaller than the demand.  That is referred to as a seller's market.  Sellers have their pick of buyers, can push up their prices and be less willing to offer incentives. 

If there are 1200 homes on the market, buyers have the upper hand.  Now the supply is outstripping demand.  That would be the classic definition of a buyer's market.  In this case, buyers can make more demands of sellers and prices are generally pushed down. 

Careful though...

Right now in Gwinnett County Georgia there are several markets happening all at once.  I compile sales data for a variety of markets and micro-markets and see conflicting data... 

  • In Gwinnett County, overall we have about an 8.6 month supply of homes. 
  • In Duluth, for homes under $200,000, the supply is about 6.1 months. 
  • In Suwanee, for homes under $200,000, the supply is only 4.6 months.
  • Also in Suwanee, for homes over $1,000,000, the supply is 45 months. 
  • (please note, these are all using a 6 month sales average)

A little more about time frames...

Generally, in real estate we use 3 month, 6 month and 12 month averages.  To arrive at these, we look at sales data for the time period (3, 6 or 12 months), divide it out monthly, and then divide that into the number of available homes in that market. 

The fun part is that we can glean additional information by comparing these three numbers.  Let's go back to Suwanee... 

  • The 12 month Absorption Rate for homes under $200,000 is 5.2 months of inventory...
  • The 6 month Absorption Rate for homes under $200,000 is 4.6 months of inventory...
  • The 3 month Absorption Rate for homes under $200,000 is 4.3 months of inventory... (note, the November sales data isn't yet complete, and this number is actually going to get better...)

Comparing these numbers tells me that that sales in this segment were actually accellerating.  As we got more recent, the average sales per month increased.  Of course there are a few things to keep in mind...

Limitations and other notes...

To start with there is "seasonality".  This means that there is an expected change in the pace of sales because of the time of the year.  Here in the Atlanta area, sales generally pick up in the late spring and early summer.  They also tend to fall off of a cliff in January.  So, just because we see an accelleration doesn't mean that it isn't natural. 

The next thing we have to consider is "outside influence".  Right now, that would be the First Time Home Buyer Tax Credit.  It was originally slated to expire at the end of November.  So... there was a rush to get under contract in October.  And a rush of closings in November.  We'll have to see if the pace holds... 

Which brings us to the next point...  We can't predict the future.  We can look at the past and we can theorize about how outside influences are going to alter future trends.  But that is it.  How many times has the NAR said that "Now is the time to buy" or that they "see growth moving forward"?  Obviously over the last couple of years, they were WAY wrong.  I have made my share of mistakes.  Sometimes it is because we make wrong assumptions, and in other cases, things change...  Maybe the government changes FHA qualifications...  Perhaps there is a new tax credit...  A large employer could relocate... 

 

I hope this helps you understand the real estate (and other) markets a little better.  Market reports are often dry and full of stats, but understanding them can be a great way to understand why the market is moving.  Understanding why helps you better understand what you should do.

 

from LaneBailey.com

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Re-Blogged 7 times:

Re-Blogged By Re-Blogged At
  1. Michael Setunsky 12/04/2009 11:58 PM
  2. Joan Lorberbaum Moore 12/06/2009 02:20 AM
  3. Sandy McAlpine 12/06/2009 11:45 PM
  4. Chris Shouse 12/07/2009 03:20 AM
  5. Bob & Leilani Souza 12/07/2009 08:52 PM
  6. Tim Ludemann 12/20/2009 12:39 AM
  7. Toula Rosebrock 01/16/2010 03:12 PM
Topic:
Real Estate Market Trends
Location:
Georgia Gwinnett County
Groups:
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Tags:
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Rainmaker
361,889
Jeanne Dufort
Coldwell Banker Lake Country - Madison, GA
Madison and Lake Oconee GA

Terrific post!

The problem I'm having in my rural and resort market just east of you (Georgia's Lake Country, featuring Madison and Lakes Oconee and Sinclair) is that the paces of sales is simply so slow and the inventory so varied, that a standard "abosrption rate" analysis give meaningless date.

For example, in the local board MLS (LCBOR), you'll find that just 2 Lake Oconee waterfront homes have sold this year priced above $1M.  But there are 76 on the market priced above $1M - 26 of them priced above $2M.  The lending climate for second homes and jumbo loans has just about killed the business.

I would be very leary of any analysis that relies on "total market" absorption - all real estate is local, and all meaningful absorption rates are price and property-type specific.

 

Dec 06, 2009 12:03 AM #12
Rainmaker
184,947
Cathy Tishhouse
RE/MAX Showcase Homes - Royal Oak, MI
Royal Oak Real Estate

I always hear "Absorption Rate" and know what it is but never calculated it.  This is a great post to explain to the lay person an understanding of what it is and then for a Realtor (and lay person) how to allow for all the differentials that can exist.  Very helpful to me - Thanks.  It's time that I start calculating this and getting familiar with it.

Dec 06, 2009 03:58 AM #13
Rainmaker
1,543,435
Lyn Sims
RE/MAX Suburban - Schaumburg, IL
Schaumburg IL Real Estate

I did understand absorption rate until I read your post.  I just use months supply of inventory around here.

Dec 06, 2009 06:17 AM #14
Rainmaker
212,987
Sandy McAlpine
RE/MAX EXECUTIVE - Cornelius, NC
Search Lake Norman Homes For Sale - Lake Norman NC

I absolutely loved your blog on Absorption Rate. It is clear and helps the buyer or seller understand in "Pizza" terms!! I love it and reblogged it. Thanks

Dec 06, 2009 11:46 PM #15
Rainmaker
678,889
William James Walton Sr.
WEICHERT, REALTORS® - Briotti Group - Waterbury, CT
Greater Waterbury Real Estate

I'm glad you explained this thoroughly, Lane. I had a general idea of what absorption rate was, but every time I saw it, I would start thinking like a non-realtor: what the heck is that? I never use the term in my market reports, but I suppose that I can use the concept to drive home some points to buyers and sellers in my market areas.

Dec 07, 2009 12:07 AM #16
Rainer
15,273
Chris Shouse
Lyoness USA - Las Vegas, NV
Realtor - Las Vegas

Very good Lane I love the analogy and it is very well thought out.

Dec 07, 2009 03:18 AM #17
Rainmaker
334,052
Ty Lacroix
Envelope Real Estate Brokerage Inc - London, ON

Lane, well written and discriptive, it should help understand absorption better

Ty

Dec 07, 2009 03:41 AM #18
Rainer
117,648
Beverly of Bev & Bob Meaux
Keller Williams Suburban Realty - West Orange, NJ
Where Buying & Selling Works

Very good post. Your area is lucky to have an agent that not only understands terms like this but knows how to translate them into simply terms everyone can pick up on. the pizza analogy works well. When you know how to read absorption rates and can combine that knowledge with price points the outcome is information-packed. Keep it up.

Dec 07, 2009 08:56 AM #19
Rainmaker
1,047,200
Bob & Leilani Souza
Souza Realty 916.408.5500 - Roseville, CA
Greater Sacramento Area Homes, Land & Investments

Lane, I found this re-blog on Michael Setunsky's blog and I think it's the best explanation of absorption rates for the general public I've read...so I'm re-blogging this, too...thanks! :)

Leilani

Dec 07, 2009 08:52 PM #20
Rainmaker
82,132
Patty Keller
AnotherME, LLC - Atlanta, GA
AnotherMe - 770-414-9393 - RE Virtual Assistant

Lane - you have a wonderful way of explaining things!  Have you ever considered teaching!  This was educational, entertaining and enlightening!  (how's that for alliteration?)

Dec 07, 2009 10:51 PM #21
Rainmaker
594,825
Laura Giannotta
Keller Williams Realty - Atlantic Shore - Little Egg Harbor, NJ
Your Realtor Down the Shore!

Lane great way to make this understandable!  I too found it on Michael's blog, but wanted to let you know how helpful that analogy will be for my clients!

Dec 10, 2009 01:09 AM #22
Ambassador
890,780
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Sorry it has taken so long for me to answer back on this post...  Can you tell what was for dinner that night?  I enjoy breaking down terms and concepts to things that are easier to understand...

Dec 12, 2009 12:37 PM #23
Rainer
232,708
Tim Ludemann
Ochopee, FL

thanks for breaking it down...very easily understood after your explanation...side note bang for buck Costco pizza's are great!

Dec 20, 2009 12:39 AM #24
Ambassador
890,780
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Tim - Their sausages in the cafe are pretty good, too... and CHEAP.  ;^ )

Dec 30, 2009 07:12 AM #25
Rainer
69,150
Sue Wettstein Brazzel & Dipper Wettstein
Howard County, MD - RE/MAX 100 - Columbia MD - Columbia, MD
"Fast, Efficient, Hassle-Free Service!"

Lane,

I love the pizza analogy and the caveats about influencing factors in the statistical analysis.  Also, you gave a clear and concise explanation of absorption rate.  Thanks.

Sue

Jan 03, 2010 01:58 AM #26
Rainmaker
545,096
Toula Rosebrock
Diane Turton, Realtors, Forked River, NJ - Lacey Township, NJ
Broker/Sales Associate, Realtor, Lacey Township,

Hi Lane:

Your explanation and pizza analogy was great!

 

Jan 06, 2010 11:28 AM #27
Ambassador
890,780
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Sue and Toula - Thank you both... 

Jan 07, 2010 01:41 AM #28
Rainmaker
545,096
Toula Rosebrock
Diane Turton, Realtors, Forked River, NJ - Lacey Township, NJ
Broker/Sales Associate, Realtor, Lacey Township,

ToulaRosebrock,com

Hi Lane:

Just want to let you know, I re-blogged this post.

Great job!

Jan 16, 2010 03:15 PM #29
Rainmaker
318,971
Tamara Inzunza
RE/MAX Executives - Alexandria, VA
Close-In Alexandria and Arlington Living

You definitely have to compare zip codes and price ranges when it comes to absorption rates.  The luxury market is moving slower than the range of homes for first-time buyers.

Feb 08, 2010 03:47 AM #30
Ambassador
890,780
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Thank you both - I appreciate the re-blog.  And remember, absorption rates change constantly. 

Feb 10, 2010 01:47 PM #31
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