Absorption Rate for Dummies

Note: To use this calculator, enter the number of units sold in the last 12 months in your market or market subset, then enter the number of active listings for the same market or market subset. You may also use a shorter time period as long as you annualize the result. For example, you might use the last 3 months sales data multiplied by 4 to represent a full 12-month period.

Want to impress your clients and stand out in a sea of average agents?  Who doesn’t?!  What if I told you that you could learn a simple calculation that would set you apart from 95% of the other agents?  Sound too good to be true?  Trust me, it’s not!

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.  Our company created the following 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!  Now how cool is that?!  Let me know what you think.

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Comments 8

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  5. author Scott Weber posted May 11th 2010. 2:30 am Reply

    Just reviewing your calculations for an absorption rate… By working with annual numbers, are you not averaging the yearly absorption? How would you average it monthly? I was taught that a simple calculation is “number of current inventory” divided by “how many sold in the past month” would give you how many months of inventory there is. ( Eg: using your numbers from above and converting an annual sold numbers to monthly (8000/12=666.67) … An inventory of 2000 / 666 sold in the past month = 3 months of inventory.

    • author Matt Jones posted May 11th 2010. 4:53 am Reply

      Hi Scott. Thanks for reading and for your comment. I am not sure I got all that, but I am teaching the “traditional” method of calculation. If you have enough data, you can annualize last month’s data, then calculate the same way. Sample size is important for relevance. If your market did not have at least 400 sell last month (enough for a 5% margin of error) you probably need to do larger time periods. Hope that helps, and thanks for reading.

  6. author Jonathan Wilcox posted June 20th 2010. 1:59 pm Reply

    The only thing I’ll add is the inclusion of a sales ratio in your newsletters or presentations.

    The only problem is that a lot of MLS’s make this data difficult to pull out of the data. The sales ratio is the number of homes that sold in a given period of time versus (divided by) the number of discrete homes put on the market in that same period.

    I can tell you that most Associations and MLS’s don’t want to publicize this data because it shows how much wasted effort there is in real estate brokerage due to gross over-pricing by both brokers and owners.

    • author Matt Jones posted June 20th 2010. 2:20 pm Reply

      Thanks Jonathan,

      That would be great info to have on a market specific basis. I can’t get the data from my MLS, or if I can, I don’t know how. I know that nationally, according to the NAR, about 55% of all listings sell. I have never been able to pull the data for just my market. I kept it for myself (and it averaged between 64-70%) so I could tell a potential listing client how much better we did than the market using my approach (see The Ultimate Listing Presentation) but the hard data for my own market was never available. Any ideas how to get it? I would love to know.

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