Numbers of sales and median prices are two simple ways of measuring demand in the housing market. Another important figure is the market’s absorption rate.
What Is the Absorption Rate?
The absorption rate is defined as the rate at which homes that are available in a market are sold over a given time frame. The rate is calculated by taking the number of homes sold within a period—say, over 30 days—and dividing that number by the total number of available homes in the market. Let’s assume that in a housing market, there are 1,000 homes available for sale. Since we’re in a seller’s market, 250 of those homes quickly sold in just a month’s time. The absorption rate in this market is 25%, which is the rate you get when you divide 250 by 1,000. Or, say there’s a housing market with 2,000 homes available for sale within a single price range and only 50 of the homes sold over the last 30 days. In this case, the absorption rate would be 2.5%: 50 divided by 2,000. Housing markets with an absorption rate of more than 20% are considered to be seller’s markets. On the other hand, those markets with an absorption rate lower than 15% are buyer’s markets. Flipping the equation gives you an idea of how long it would take for a given market to run out of housing inventory. To calculate this, divide the total number of available homes by the number of homes sold over the given time frame. Using the first example above, you would divide 1,000 by 250, which means it would take just four months for that market to run out of homes for sale.
How Is the Absorption Rate Used?
Professionals in the housing industry are interested in the absorption rate for various reasons. Real estate agents and brokers use it to help decide how to price a home for sale. In a seller’s market where available homes don’t stay on the market for long, agents and brokers are able to bump up the price, since there’s an elevated level of demand and greater competition for the housing stock. Along with reviewing historic prices against today’s values, appraisers factor in absorption rates when evaluating what a home is worth. Absorption rates can also serve as a gauge for builders trying to figure out whether it makes sense to build more homes now or wait for a better market.
What Other Factors Affect Demand?
Changes in mortgage interest rates have the ability to make or break whether consumers enter the housing market. Economic influences causing rates to jump significantly over the course of a few months could delay someone’s home-buying goal. For example, if the Federal Reserve is expected to raise the federal funds rate, this may ultimately but mostly indirectly affect mortgage rates. Changing demographics, such as the large number of millennials reaching prime home-buying age, can also affect real estate demand. Federal and state legislation, notably tax incentives, can also be a factor.
