Making accurate predictions about the real estate market is what every investor strives to do, however, it’s very tough to consistently achieve accuracy in an ever changing market. Real estate professionals have many measurable indicators that help increase accuracy when making predictions, such as neighborhood comps, surrounding development, inventory, employment opportunities, and more.
Calculating a variety of factors, numerous times can be unmanageable for some. Fortunately, there is one measurement in particular that is reliable and simple, known as the absorption rate.
What is the absorption rate?
The absorption rate measures the rate at which homes are sold in a specific market, during a certain period of time. It shows how quickly, or slowly, homes are being moved off the market and can help real estate professionals determine the viability of the market and if it’s a buyers or sellers market. It can also help sellers figure out the most competitive price for listing their properties.
How does the absorption rate work in real estate?
In order to implement the absorption rate into your investment strategy you must understand the calculation. The absorption rate calculation is very simple. You must divide the number of properties sold in a given period of time by the total number of active listings during that time period. For example, let’s say last month there were 3,000 properties for sale in Tampa, FL and 880 of those properties sold in that same month. The absorption rate would be 29%.
Written as an equation where PS = Properties Sold, LP = Listed Properties, and AR = Absorption Rate:
(PS/LP) * 100 = AR (%)
Industry professionals would say anything above 20% is considered a good absorption rate. This indicates a strong market for sellers as it means properties are being moved off the market rapidly. An absorption rate below 15% is considered to be slow, and therefore, a buyers market.
The formula for the absorption rate is flexible and can be customized to fit whatever location and time frame you’re looking for. It can also be used for different types of properties, such as multifamily rentals. To calculate the absorption rate for a multifamily rental unit you would find the total number of units, determine a time period, calculate the number of units rented during that time and then divide that number by the total number of units.
What is the significance of using absorption rates in real estate investing?
Although you will still want to calculate other measurable indicators prior to choosing an investment strategy, the absorption rate is a quick calculation to add to your arsenal. The more aspects of the market you can analyze, the better chance you have at achieving success with your investments. Absorption rates can be done at any point in your project and can give reliable predictions at a glance that help you navigate a dynamic real estate market.