Allow me to introduce you to Absorption Rate. Before your mind wanders off into numbness, let me also tell you that this is one of the most practical metrics or measurements you can learn for your market or for subsets of your market. And better yet, it will only take you a few minutes to learn it. Although the manufacturing segment of the economy has been using this metric for decades, real estate, for the most part still doesn’t.
OK, so what is Absorption Rate? Simply put, it is the rate at which a market absorbs or eliminates inventory. Markets are always changing: new inventory is being added and old inventory is being sold or absorbed. Absorption rate helps you to take that fluid, ever-changing market and bring it into a measurable snapshot that you can use to advise your clients.
When I was still in college I took a class on managerial calculus (I know… YICK!) and one of the only things I remember from the class was a small section on inventory modeling. It seems that one of the practical uses for higher mathematics was to allow industry to determine the precise level of inventory to stock. Stock too much, and the company tied up cash or debt in sitting inventory and carrying costs. Too little, and the company would lose sales by not having the products on hand.
Now let’s take the logical step and apply it to real estate. Suppose you had a builder as a listing client. Using absorption rates for various price points, you could wisely advise him on which price points to focus on in order to maximize his sales. Or suppose you were going on a listing appointment and you were able to advise your client of the number of month’s inventory of homes like his that are currently on the market. Would that information be valuable in winning the listing? Of course it would be!
What if you were working with a buyer, negotiating for his dream house. Imagine if you were able to communicate to the seller’s agent that there was over a year’s worth of inventory currently on hand for that particular price or type of home? You could easily give the listing agent the information he needed (and probably didn’t know) to help him persuade his client to consider your buyer’s offer.
Well, believe it or not, it’s easier than you might think to have those numbers. All you need to know is how many of a certain price or type of property sold in the last twelve months, and how many of that same price or type of property is currently on the market. For example, let’s say that in the last 12 months there were 8,000 homes of a certain price or type sold. Currently, there are 2,000 on the market. That means that the current inventory level turned over, or sold, four times in a year. (8,000 / 2,000 = 4.0)
Now, divide 12 (the number of months in a year) by 4.0 (the inventory turnover rate) and you have 3.0 (the absorption rate) to put it into months. The absorption rate is 3.0 months. That means is there is currently a 3.0 month inventory of properties of that certain price or type on the market. See how easy that was? But I’ll make it even easier. We created this Absorption Rate Calculator for you to use and it does all the math for you. Just plug in the two numbers, press the button, and voila… the absorption rate! So check it out and then let us know what you think.