2007 Nov 19th

Absorption Rate – What it Means and Why You Need to Know It

Absorption rate is a measure of supply. It gives us a way to calculate how long it would take to sell all the units currently for sale. It helps both buyers and sellers understand what’s going on in the market.

Most sellers, when pricing their own property, look to see what their neighbors got for their place. What that doesn’t tell them, however, is how saturated the market is with other properties for sale at the time that they want to sell. Absorption rate is a way to judge how much supply is out there against which, you, as a seller, are competing.

Absorption rate is important to buyers, too. If you are a buyer in a market with lots of inventory – guess what – you will have a better chance at negotiating a lower price. Basic economics teaches us that prices in any free market are determined by supply and demand. If demand is constant, an increased supply means prices will drop to restore balance in the market. When there is not much supply, buyers pay more to get the scarce item.

This is how absorption rate of Hoboken condo units would be calculated:

Take the number of properties that have actually sold over a period of one year. As a Realtor, I can pull this data right from the MLS. Take the total number of condos sold in the past year. Divide that number by 12 to get a monthly figure . Divide the number of properties actively for sale this month by the result and you get the absorption rate. It tells us how many months it should take to “sell out” all of the properties currently for sale. In our case, it should take just over five months for the market to “absorb” all of our current inventory.

Condo units listed on the MLS sold in the past year: 530

Monthly figure: 82

Active condos today: 530

Absorption Rate = 5.4

According to the National Association of Realtors, six months supply is considered a balanced market. That indicates that the number of listings, or properties for sale roughly equals the number of buyers. A number over six represents a buyer’s market and a number under 6 a seller’s market. We can also look at absorption rate by price range or by unit size. Here is an example:

studios and one bedroom units: 384 sold, 136 active = 4.25 absorption rate

two bedroom units: 515 sold, 243 active = 5.6 absorption rate

three bedrooms and bigger: 87 sold, 61 active = 8.7 absorption rate

Good news for one bedroom sellers. Good news for two bedroom sellers. But bad news for the sellers of the big units. This may seem counterintuitive to the demographics of the Hoboken condo market. We all see lots of strollers on Washington Street and the parks are full of kids. You would think there would be a huge demand for the bigger units to house our growing number of families. Keep in mind, however, that we looked only at condos so all those uptown brownstones are not included in the above analysis. Another thing to remember, is that all these figures come from the MLS. The huge, new projects, like Maxwell Place, are mostly not listed or sold on the MLS so they’re not included in this study. It would be interesting to see how the increase in supply thanks to Maxwell and all the other new construction around town that is sold directly by the developer, would impact the absorption rate. My guess is that the 5.6 and 8.7 numbers would be a bit higher, due to the added inventory.

It is also possible, using absorption rate, to look at sales trends over time. If you calculate supply over any number of three or six month periods you will get an indication which way the market is trending. Like other industries, real estate prices are mostly a matter of supply and demand. While absorption rate may just be a guide, it is another valuable tool for buyers and sellers to better understand the real estate market and assist them to make informed decisions.

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