“Absorption Rate” Analysis Benefits Buyers And Sellers

Sunday, 11 Dec 2011, 12:55:00 AM

Michael Edlen

It’s become far more challenging to answer the frequent question: “How is the real estate market doing now?”

More than ever before, it all depends on which specific housing market area is being considered.

When the generalized perception of the housing market is more carefully examined, it becomes clear that an understanding of the marketplace requires specificity. Significant differences exist even within communities such as Santa Monica.

One of the most reliable approaches to answering the question in a way that is valid in any area is to use what has been termed “Absorption Rate Analysis.”

This refers to how many homes are being absorbed by the housing market on a monthly basis and how this may impact home sales and values.

Absorption Rate Analysis has been used in commercial real estate and in the new homes industry for many years, but has been used infrequently in residential resale market places. The first time I recall this being used in home sales was in the mid 1990s, which was the last time it was a difficult “buyers market” in most areas. The absorption rate analysis approach to understanding the residential market can be used regarding different time periods and specific price ranges.

As a general rule, if there are five months or less of inventory, it is in a “seller’s market” with price appreciation likely. If there are six or seven months of inventory, it is generally considered to be a transitioning market with relative price stability. If there are eight or more months of inventory, it would be characterized as being a “buyer’s market” with downward pressure on prices.

Many ask, “Are we still in a “buyer’s market” in all Westside neighborhoods?” absorption rate analysis indicates this is not the case. In some areas of the Westside we have an inventory level so low that it clearly could be considered a “seller’s market.” Current absorption rates in various neighborhoods range from four to 20 months.

For people planning to buy or sell in any particular area, an understanding of the current absorption rate can be very helpful in making intelligent listing or purchase decisions. The calculation, while somewhat detailed, is really quite simple in concept. It begins with the following steps: identification of the search area, price range, and time for analysis. The longer time range will give a better overall average, whereas shorter times will give most recent trends. The steps in calculation include the number of homes sold in that time period, divided by the number of months; then compare that figure with the number of homes for sale in that particular area and price range at that moment in time.

The number of homes available on the market can vary substantially over time, which is one reason why this approach to understanding the local market needs to be done very carefully and in a timely fashion.

For the past 25 years Michael Edlen has provided real estate counseling services to prospective buyers and sellers. Most of his business is derived from a referral base of nearly 1,000 past clients. More tips and information are available on MichaelEdlen.com. He can be reached at 310.230.7373 or Michael@MichaelEdlen.com.

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