This was a fantastic post written by Lane Bailey of Lilburn, FA explains Absorption Rate:
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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.
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.