What Is the Absorption Rate and How Is It Calculated?

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What is a market absorption rate and how is it calculated? This is a topic many people in the Palm Springs area have asked me about, so today I want to demystify this helpful statistic.

The market absorption rate is the number of months required to sell all the homes currently listed for sale if no other homes come onto the market in the interim. To calculate this rate, most people use a baseline of six months of sales.

Let's use the city of Palm Springs as an example. At the end of January 2016, there was a total 805 homes sold in the previous six months. If you take 805 and divide it by six, you will find the rate of the number of homes sold each month, which comes to 134. Taking the current inventory, as of the end of January, which is 938 homes for sale. Once you divide that number by 134, you will find your market absorption rate, which is seven! This means that in seven months, if no homes are added to the market, the entire inventory of available homes will be sold out!

In order to anticipate market activity and home price action, it's helpful to look back at historic absorption rate numbers for our market. Let's say this particular market has seen several six month periods in the recent past with inventory levels sitting between five and six months worth of homes for sale. A slowing down of sales -- which gives us a slower, seven-month absorption rate -- will put downward pressure on home prices and is indicative of a buyer's market. Simply put, the market absorption rate is a number that gives us an idea of how strong demand is and how much supply is available.

New rules that went into effect after the market crash require appraisers to consider the absorption rate in their calculations. They must look at trends in the market and compare historic numbers with the current market. If they see a longer absorption period in the current market, they may need to lower the valuation to adjust to the slower sales. For buyers, if a specific area or neighborhood is experiencing a low market absorption rate, it can be difficult for a buyer to find a suitable property. This market is typically referred to as a seller's market, and this can result in buyers having to pay more for a home.

A buyer who is aware of the market absorption rate in a given area gives themselves an advantage over other buyers. If a buyer knows the market is in their favor, they are in a position to ask for additional items from the seller, such as seller concessions, a home warranty, or even a discounted price. For sellers, the market absorption rate is a great indicator of what the current market is like and will help them determine the best time to put their home on the market. If they can afford to wait to list their home, it's best to do so when the market isn't in the buyers' favor.

Generally speaking, an absorption rate of anywhere from zero to five months means it's a seller's market. If the market absorption rate falls between five and seven, the market is balanced and neither buyers nor sellers have a distinct advantage. If the absorption rate exceeds seven months, we are in buyer's market, meaning there are more homes for sale than there are buyers looking. Regardless of the side of the real estate market you're on, knowing the absorption rate is crucial if you want to make informed decisions.

If you have any questions about this or any other real estate topic, please reach out to me! I'm always available to help and would love to hear from you!