What is the absorption rate?
The term absorption rate refers to a metric used in the real estate market to assess the rate at which available homes are sold in a specific market during a given period of time. It is calculated by dividing the number of homes sold in the allotted time period by the total number of homes available. This equation can also be reversed to identify the amount of time it would take for the supply to be sold. Absorption rates are also a key part of the accounting industry. In this context, the absorption rate refers to the way companies calculate their overhead costs.
- The absorption rate is commonly used in the real estate market to determine how many homes are selling in a market at any given time.
- The equation can also be used to calculate how long it would take to sell the home supply on the market.
- An absorption rate above 20% has indicated a seller’s market and an absorption rate below 15% is an indicator of a buyer’s market.
- Absorption rates are also used to determine overhead costs in accounting.
- Businesses generally use estimates to calculate their overheads, which means they have to make adjustments to their balance sheets when actual costs come in.
Understand the absorption rate
The absorption rate provides information on how fast or slow houses are selling on the real estate market. An absorption rate does not take into account additional homes that enter the market at different times. That’s because this only provides a figure based on currently available data.
A high absorption rate may indicate that the supply of available homes will shrink rapidly, indicating that a homeowner will sell their property in a shorter period of time. Traditionally, an absorption rate greater than 20% indicates a seller’s market in which homes are selling quickly. An absorption rate below 15% is an indicator of a buyer’s market where homes are not selling as quickly.
Real estate professionals, such as brokers, use the absorption rate to set home prices.
Influence on the real estate market
In market conditions with low absorption rates, a real estate agent may be forced to lower the listing price to attract a sale. Alternatively, the agent can raise the price without sacrificing demand for the home if the market has a high absorption rate. The absorption rate is also important for buyers and sellers to follow while making decisions about the timing of purchases and sales.
The absorption rate can be a signal for developers to start building new homes. In market conditions with a high absorption rate, the demand may be high enough to justify further development of the properties. Meanwhile, periods with lower absorption rates indicate a cooling period for construction.
Appraisers use the absorption rate to determine the value of a property. Some procedures require an appendix showing that absorption rates were considered in the appraisal calculations. In general, appraisers are responsible for analyzing market conditions and maintaining an understanding of absorption rates for all types of appraised values.
Most appraisers include this data metric in the neighborhood section of appraisal forms. The current valuation of a home would decrease during periods of declining absorption rates and increase when absorption rates are high.
Absorption rate example
Suppose a city has 1,000 houses currently on the market to be sold. If buyers purchase 100 homes per month, the absorption rate is 10% (100 homes sold per month divided by 1,000 homes available for sale). This also indicates that the supply of homes will be exhausted in 10 months (1,000 homes divided by 100 homes sold / month).
Do you want to know if it is time to sell your home? Find the number of homes sold in your area on the MLS website and use the formula above to determine how long it will take to sell your property.
Absorption rate in accounting
As mentioned above, the accounting industry also uses absorption rates. This is the rate at which businesses calculate their overhead. These are the costs associated with supplying goods and services to your customers. As such, it is also often called the air absorption rate.
Businesses often have to use estimates to determine their overhead costs. That’s because they don’t know what the real costs are until they come in. To determine their overhead, companies divide their budgeted overhead divided by the total budgeted production base. This requires an adjustment at the end of the accounting period to make up for any difference between expected and actual costs.
This can be problematic, especially when companies use very conservative estimates to predict their costs. Doing so can upset your balance sheets because actual costs may be higher at the end of the reporting period or if costs fluctuate.
Frequently asked questions about absorption rate
What is the formula for the absorption rate in real estate?
To find the absorption rate in real estate, divide the total number of homes sold in a specific time period by the total number of homes available in that market.
What is a 6 month absorption rate?
Absorption rates indicate how long it takes to sell homes in a given market. A six-month absorption rate indicates a balanced market, so buyers and sellers benefit equally during this environment.
How is a monthly absorption rate calculated?
To determine a monthly absorption rate, take the total number of homes sold on the market and divide it by 12.
The bottom line
The absorption rate is a very important metric that is used in the real estate and accounting industries. Real estate agents use it to determine how many houses are selling in a particular area at any given time. These professionals can also use the rate to determine the type of market they face, be it a buyers, sellers, or balanced market. This rate is also important for the construction industry, as it indicates when developers should start buying. Equally important is how this rate is used in the accounting field, especially for companies to estimate their overhead. You can use the formulas above to determine these rates.