What is an absorption rate in real estate and how is it calculated? It’s important to know all about absorption rates when looking at the state of your local housing market and making investment decisions. Let’s break it down for you.
What is the Definition of an Absorption Rate in Real Estate?
When it comes to analyzing the housing market, the absorption rate refers to a method of determining how quickly properties are being sold.
Absorption rates in real estate are a measure of supply and demand. Real estate professionals like us use this statistic as a gauge for how our local market is performing – whether it is a “buyer’s market,” a “seller’s market,” or a “balanced market.”
When you see a real estate absorption rate, you’re looking at the average number of houses selling in that market compared to total listings available.
How are Real Estate Absorption Rates Calculated?
There are a few ways to calculate and present an absorption rate in real estate.
Monthly Absorption Rate Formula for Real Estate
Most often, you will see the absorption rate presented as a percentage. The formula used to calculate it helps summarize how a certain housing market performed in a given month – specifically, what percent of listings were “absorbed” by buyers that month.
Many times this simple monthly calculation is used for the absorption rate: divide the total number of houses sold in one month by the number of active listings on the market at the end of that same month. Turn the resulting number into a percentage – and there you go.
Sample Monthly Real Estate Absorption Rate Calculation
At the end of September 2023, there were 623 homes actively for sale on the Virginia Beach housing market. Throughout the month, 463 houses had been sold in Virginia Beach.
When you divide the number of homes sold by the available listings (463 / 623), you get an absorption rate of 0.6799, or about 68%. (Take note that because of the historical supply and demand of the post-pandemic Virginia Beach housing market, absorption rates in this area and others are historically high.)
12-Month Rolling Average Absorption Rate
While helpful for a quick and simple look at real estate market activity, data from just one month may not give a holistic and accurate picture of housing market trends.
For that reason, many real estate professionals will use a 12-month rolling average absorption rate. This version uses the average number of houses sold per month over the past year. It’s a great way to get a fuller look at absorption rate trends, as it factors in the seasonal nature of the real estate market.
To calculate this, take the total number of listings sold in a certain market over the past 12 months. Then, divide that number by 12. That will give you the average number of homes sold each month in the past year.
Then, divide the average number of homes sold by the number of active listings on the market at the end of the last month.
Sample Rolling Average Absorption Rate Calculation
Let’s look again at the Virginia Beach housing market for our 12-month rolling absorption rate.
From October 2022 through September 2023, 5,661 existing homes were sold in Virginia Beach. When divided by 12, that makes a rolling average of 471.75 houses sold per month.
To get the rolling average absorption rate, we’ll divide that average of 471.75 by 623 (the number of active listings on the Virginia Beach housing market at the end of September 2023). This gives us a 12-month rolling average absorption rate of 0.7572, or about 76%.
Calculating How Fast the Housing Market Will Sell Out (MSI)
Absorption rate analyses are often accompanied by calculations of “months supply of inventory,” or MSI. This helps determine how quickly active inventory on the real estate market would sell out if no additional listings were added.
To get the month's supply of inventory using the monthly absorption rate, simply turn the simple absorption rate formula on its head:
So, using our data from the sample monthly absorption rate calculation, you divide the 623 active listings in Virginia Beach at the end of September 2023 by the 463 houses sold in the same month to get an MSI of 1.3455. So, if houses continued to sell at the same rate as they did in September, Virginia Beach would completely run out of listings in 1.35 months if no new inventory was added.
Data from the rolling average absorption rate formula tends to provide a more accurate idea of MSI. Some real estate data centers like Hampton Roads’ REIN will use this method exclusively, as it uses statistics from the past 12 months of market activity. This allows for seasonal market trends to be a contributing factor in their housing market outlook.
Let’s use our previous example of Virginia Beach, where the rolling average absorption rate was about 76%. If active listings last month totaled 623 across the Virginia Beach housing market, and the monthly average of houses sold was 471.75, then the MSI would suggest that inventory would sell out in 1.32 months if no listings were added.
(Of course, remember that when you see this type of calculation that there’s typically a good chance more inventory will be added to the market before all the current listings sell out.)
What Does a Stable Absorption Rate Look Like?
An absorption rate that indicates a balanced real estate market will fall somewhere around 15-20%. Generally, anything lower than 15% suggests a buyer’s market where houses are selling slowly. An absorption rate that is higher than 20% indicates a seller’s market with houses selling pretty quickly.
Likewise, a balanced market has historically been viewed as having a 5- to 6-months supply of inventory. Anything less than five can indicate a seller’s market, and anything higher might mean buyers have the upper hand.
Absorption Rate vs. Housing Market Inventory
The absorption rate is highly impacted by real estate market inventory. It’s inversely correlated with MSI, so when absorption rates are high, MSI tends to be lower (and vice versa).
If there aren’t many listings on the housing market, a high absorption rate could indicate that it’s a competitive market, or a seller's market. Properties are likely to sell quickly and for more money. Buyers need to be extra prepared to act fast and work with a top real estate agent.
High MSI and a low absorption rate may indicate houses are taking more time to sell. This can allow inventory to increase over time, creating a buyer’s market. Sellers will want to work with a professional who can help them strategize to sell their house quickly.
Housing developers are often guided by absorption rates as well. They usually look at absorption over a longer period when running their calculations. When absorption rates are higher, development companies may be enticed to build more homes because there’s a good chance they will sell quickly. In times of low absorption, the construction industry tends to be less busy.
Absorption Rate Impact on House Prices
Because of the nature of supply and demand, higher absorption rates tend to drive higher house sale prices. When there’s a seller’s market, buyers are usually spending more on average for a home.
If the local absorption rate is lower, those looking to buy a home may see listing prices being reduced for homes on that market.
Absorption rates are also used by appraisers and lenders in real estate. Because supply and demand tend to directly impact house prices, appraisers can use local absorption rates to adjust how they value a property. Similarly, lenders may adjust the terms of loans with insights from an absorption rate formula. Homebuyers may be able to get more favorable loan terms when the absorption rate is low and lenders are hungry for new business.
The Bottom Line
Real estate absorption rates are an important housing market statistic to be familiar with whether you are buying a house or selling one. It’s an easy way to measure the health of your local market by looking at how quickly homes are selling. They can inform your strategy to navigate the current market.
Whether your current real estate absorption rates indicate a buyer’s market or a seller's market, it always pays to work with an expert real estate agent or Realtor® who knows the market and its data inside out.