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Understanding Absorption Rate And Its Importance

In Real Estate

Description
If you are a real estate buyer and have done considerable research on current
property market scenario, you might have come across the term 'absorption
rate'. This is a widely used term amongst real estate pundits who are charged
with the responsibility of analysing market trends and give a clear picture to real
estate investors. But how is it important for real estate buyers? Here is the note-

What is absorption rate?

Absorption Rate is defined as the rate or the time that will be taken to sell the
existing stock of homes listed in the specific real estate market. Though it sounds
like simple mathematics, it holds great importance for real estate investors and
experts to assess how the market is performing. Absorption rate is a tool to predict
the future of real estate sales in a particular micro-market. It also governs the price
rise and fall in a given time.
How to calculate absorption rate?
In simple words, absorption rate can be calculated by the number of total houses
sold in the market in a previous period divided by the months taken to sell them.
Here is an example to understand the absorption rate in detail-

Suppose 30,000 homes were sold in past six months in a large urban area. So,
now divide 30,000 homes with six months to derive home sales per month. This
comes to 5,000 units per month. Now, consider there are 25,000 homes listed on
the market. Considering, that the last stock of 30,0000 homes took six months to
subside, divide 25,000 with 5,000. The absorption rate so achieved is 5. This
means that it would take 5 months to sell off 25,000 homes in the same micro
market.

How absorption rate impacts property prices?


Absorption rate is instrumental in determining the market activity and home price
movement. For instance, consider the absorption rate for any real estate market is
consistent at 5 or 6 months. The speeding up of sales can bring the rate to 4.5
months. This can indicate a price rise in future or even in the current time. In
short, the absorption rate is an indicator of demand and supply in the market,
ultimately guiding the market prices.

Why is absorption rate important?


• Absorption rate is used by real estate brokers to assess the property prices
on a regular basis that are listed in the market. It is not always that property
prices climb up due to change in absorption rate. There are times when
absorption rates can go up to 12 months or even more. In such cases, the
listing prices changes and heavy bargaining is expected.
• It can be used to compare the historical performance with the current
scenario. If the absorption period is longer than before, it can impact
the valuation of the asset as the rate predicts slower sales in times to come.

How homebuyers can use absorption rate?


Home buyers can use absorption rate to determine whether their investment can
fetch them good returns in future. A buyer should always consider absorption rate
of past two years to understand how a particular market has performed and based
on this, predict the upcoming time if he/she plans to exit the investment in the
next three years. For long-term investors, a careful and regular study of such rates
can help him decide when to exit the market and when to hold the investment.