What is an Absorption Rate in terms of Real Estate?
An absorption rate explains how many months worth of inventory, or homes, are on the market at a given time. For example, if the absorption rate is 5.2 then it would theoretically take 5.2 months for all the homes currently on the market to sell. (This is not an exact science, of course. See my disclaimer below.)
How is an absorption rate calculated? Here's how they're calculated in Champaign, though some other markets calculate them differently:
- Take the number of homes that sold in an area over the past 6 months. For example, let’s say 25 homes sold over the past 6 months in La-La Land.
- 25 homes divided by 6 months means that approximately 4.2 homes sell in La-La Land per month.
- Now we take how many homes are currently on the market in La-La Land: 28 homes. Divide 28 homes currently on the market by 4.2 homes sold per month and the answer is: 6.7 months. This is the absorption rate. It means that if homes continue to sell at the same rate they have for the past 6 months, then it would take 6.7 months for all the homes on the market in La-La Land to sell.
What does this number tell me? The general rule is as follows:
- Absorption rate LESS than 6 indicates a seller’s market (higher demand, lower supply)
- Absorption rate EQUAL to 6 indicates a stable market
- Absorption rate GREATER than 6 indicates a buyer’s market (lower demand, higher supply)
Now for my disclaimer…. Absorption rates are NOT meant to determine how and when an individual home will sell (For this you'll need to consider the individual home's price, condition, location, etc.) Absorption rates are, however, very useful in keeping watch on TRENDS for an area.
What's the trend in Champaign County?
Champaign real estate activity is highly affected by the seasons. So, for instance, the absorption rates here will be lower in the summer and quite a bit higher in the winter. Since the slowing of the market over the past few years, the absorption rate hasn’t dropped below 5 months in the summer and has risen as high as 18 months in the winter! (To put that into perspective, back in 2006 before the recession the lowest absorption rate for the year was in June at 3.7 months, and the highest was in February at 9.1 months.)
Questions, anyone? Just shoot an email my way or leave a comment below!