Absorption Rate – Definition

Cite this article as:"Absorption Rate – Definition," in The Business Professor, updated February 14, 2019, last accessed October 29, 2020, https://thebusinessprofessor.com/lesson/absorption-rate-definition/.

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Absorption Rate (Real Estate) Definition

The absorption rate in real estate is defined as the rate in which existing homes sell within a time frame, typically three or six months. This is discovered by dividing the number of houses sold with the available estates.  This rate can be used for determining the selling prices for real estate. Absorption rates are also considered by appraisers.

A Little More on Absorption Rate in Real Estate

The absorption rates only take into account the number of houses available and sold. High absorption rates indicate a potential rise in real estate prices. Likewise, it indicates that sellers have a chance to sell their properties quickly. The marker for high absorption rates is over twenty percent. Adversely when absorption rates fall below fifteen percent, buyers have more room for negotiating as houses are not leaving the market quickly.

Example of Absorption Rate in Real Estate

For example, a suburban city may have one thousand homes for sale. A potential buyer may purchase one hundred houses. If he does, his offer will be depleted in ten months. The absorption rate for this suburban city would then by ten percent. This indicates that half of the market will be sold within five months.

Users of the Absorption Rate in Real Estate

Realtors often use absorption rate when considering pricing real estate. In a high absorption rate market, a realtor may use this information to justify raising a house’s sale price. On the other end, a low absorption rate may be brought to a seller to justify lowering their house’s price.

Real estate developers use this information to decide where to invest in real estate development. Where absorption rates are high enough, developers can confidently invest in the neighborhood to sustain further development. Once absorption rates begin to drop, investors acknowledge that development is also slowing.

Appraisers consider absorption rates when finalizing their real estate value estimates. This practice began in 2009 when federal guidelines regarding Freddie Mac or Fannie Mae loans outlined the need for using absorption rates. When absorption rates are higher, the housing prices are likewise higher. The adverse is also applicable, lower adoption rates equate a lower house value.

References for Absorption Rate

  • https://www.investopedia.com/terms/a/absorption-rate.asp
  • https://www.realtor.com/advice/how-do-you-calculate-absorption-rate/
  • https://www.youtube.com/watch?v=Og3TFkF2S-M

Academic Research for Absorption Rate

  • Toward a model of the office building sector, Rosen, K. T. (1984). Real Estate Economics, 12(3), 261-269. The article examines absorption rates in relation to high rise office buildings. In order to build a high-rise, careful analysis is completed to ensure the ability to lease offices at a profitable price. The researcher finds that the absorption rate methodology is inadequate.  Rosen outlines an alternative practice that considers stock office space, the vacancy rate, and rent for office per square foot.
  • The rent adjustment process and the structural vacancy rate in the commercial real estate market, Sivitanides, P. (1997). Journal of Real Estate Research, 13(2), 195-209. The study examines the paradigm in real estate absorption. Focusing on intertemporally constant structural vacancy rate, the article argues that this measure is inherently variable. The study revises traditional rent adjustment specifications to include this variability. Through empirical results, Sivitanides argues the extended rent adjustment to be more appropriate.
  • Real estate rental growth rates at different points in the physical market cycle, Mueller, G. (1999). Journal of Real Estate Research, 18(1), 131-150. The article argues that real estate markets go through cycles that affect property price. Mueller argues that potential growth hypothesis can be made based upon an areas current position in the growth cycle. Mueller uses historical data to test his theory, finding it true. Implications include usage for potential investors.
  • Real estate valuation: the effect of market and property cycles, Born, W., & Pyhrr, S. (1994). Journal of Real Estate Research, 9(4), 455-485. The study examines the use of real estate valuation to stabilize the economy. Born and Pyhrr argue that tradition absorption rates do not take into account larger economic trends. They view this as a weakness. The scholars use a  cycle valuation system model to illustrate their hypothesis.
  • Real estate and the Asian crisis, Quigley, J. M. (2001). Journal of Housing Economics, 10(2), 129-161. Quigley examines the real estate markets in Asian economies as a primer force in the causation of the 1997 financial crisis. The study uses historical data to argue that regulatory reforms are needed to prevent another financial recession.
  • Real estate income and value cycles: A model of market dynamics, Dokko, Y., Edelstein, R., Lacayo, A., & Lee, D. (1999). Journal of real estate research, 18(1), 69-95. Through a model specification, researchers demonstrate the need for cyclic real estate models that combine traditional real estate absorption with real estate income. The model uses historical data to test their theory. Through their results, the scholars argue that this could stabilize the real estate market.
  • Real estate cycles and their strategic implications for investors and portfolio managers in the global economy, Pyhrr, S., Roulac, S., & Born, W. (1999). Journal of real estate research, 18(1), 7-68. A synthesis of recent literature on real estate cycles is used to make a hypothesis about the industries use of these models in micro decision-making processes. The researchers expand upon the need to understand the complex macro to a micro relationship in real estate, arguing it is key to successful real estate ventures. Eight cycle models are presented and analyzed accordingly.
  • The cyclic behavior of the Greater London office market, Wheaton, W. C., Torto, R. G., & Evans, P. (1997). The Journal of Real Estate Finance and Economics, 15(1), 77-92. The researchers apply an economic methodology to real estate, specifically in the London market. Using historical data, the researchers compiled estimate equations to form a complete model. The researchers argue that with no outside economic crisis, the real estate market is not cyclic.
  • Real Estate Markets Since 1980: What Role Have Tax Changes Played?, Follain, J. R., Hendershott, P. H., & Ling, D. C. (1992). National Tax Journal, 45(3), 253-266. The authors examine the impact of depreciation tax allowances in the real estate market. The paper argues that absorption rates would provide a more stable impact on the real estate market as opposed to depreciation allowances.
  • An investment model of the demand and supply for industrial real estate, Wheaton, W. C., & Torto, R. G. (1990). Real Estate Economics, 18(4), 530-547. Through an evaluation of historical data, the study finds the most recent high rise buildings are owner-occupied or occupied by a single tenant. They believe this indicates that industrial buildings are a firm investment. Using this information, Wheaton and Torto create a model to estimate excess plant capacity.
  • New ranking of decision-making subject areas for corporate real estate executives, Epley, D. (2004). Journal of Real Estate Research, 26(1), 43-68. The paper examines the skill set necessary to be a successful real estate executive. The study focused on a diverse and broad range of real estate executives. The study finds market interpretation, general analysis tools, specifically lease analysis, and personal skills to be the most important.
  • Corporate real estate risk management and assessment, Huffman, F. E. (2003). Journal of Corporate Real Estate, 5(1), 31-41. The authors examine corporate real estate risks. Huffman analyzes general risks, focusing in on decision making risks. The author provides risk management tools. The author offers recommendations for accounting for risks inherent. The overall study provides a new perspective on corporate real estate assets and risks.

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