Andrew Wetzel's Musings

June 3, 2017

Absorption Rate and Inventory Levels

Filed under: Uncategorized — awetzel @ 5:25 PM

Like most things in life, Real Estate has its own “language”. Some of it is expressed as an acronym like DOM or “days on the market” whereas some is unique language like “absorption rate” which sounds obvious until you ask a few people what it means.

We all hear about “inventory” level which, presumably we all know, means the number of houses available on the market in a defined area. But, is that relevant? What does it measure? If I told you that one area had 50 houses on the market while another had 75 what would you derive from those numbers? You might think there were more choices.

A key statistic is “absorption rate” which tells you something about how fast the buying public is consuming the available inventory. Days on the market will tell you how long the houses have sat on the market and, hopefully, the listing “status” will tell you whether a house is really available to see and buy.

Absorption rate can be expressed both in terms of how many houses are selling per month (I mean settled or closed, not just placed under contract) and in terms of how many months of supply are available. The nuance is how you “do the math”.  I recently taught an SRS (Seller Representative Specialist) designation course and explained the technical definition, got it affirmed by the class, and then told them my version. Hmmm. Realistically, both have their limitations!

Technically you need to start by looking at how many sales you had over a given period of time. The time frame has to be long enough to be statistically significant. Looking back one month is meaningless as is not knowing the time of year, the weather or if a national event has impacted the market. Just ask anyone who sold Real Estate around 9-11 or in 2008. Many of us tried to grasp what was happening. Then you need to do the math to see how many sold per month and then compare that number to how many houses are presently on the market.

For example, let’s say that 48 houses sold during the past 6 months.  That means that, on average, 8 houses sold per month. You can look at the settled dates to see the trends if you want. Then suppose there are 24 houses on the market. That would mean that you have roughly a 3-month supply of houses on the market. But do you?

First, what is an “active” listing? In my area we have houses that are technically “under contract” where the seller is still showing the house. Are they really available to buy? We also have some shrewd practitioners who do not change the listing status at all until after inspections so are they really active? There is no easy answer so I will stipulate that you will always have some aberrations within the statuses and there is no way to know all of the details. Also, my MLS allows us 3-business days to change statuses anyway so even the best of intentions muddies the water.

What about “pending” properties? The technical definition ignores them as if they are a “gray” area. Are they? I guess that depends on the ratio of pending properties that settle compared to those sales that fall through. Either way, since I look at absorption rate as a measure of “turnover”, I count pending properties as settled since they went under contract. If a sale falls through so be it. I just cannot ignore them completely.

Back to my example above, it is my humble opinion that a market selling an average of 6 houses each month is vastly different from one which is doing the same but has 12 pending properties. In the latter example, the 48 settled combined with 12 pending means that 60 properties came off the market during the prior 6 months which in turn means that 10 are removed on average each month. In that case, having 24 available houses means that there is only a 2.4 months supply of available houses. That may or may not appear significant but it is different.

During the SRS class we also discussed the technical definition of a buyer’s vs. a seller’s market. I subscribe to the thought that a 3-month supply is a “normal” or balanced market, again depending on time of year, etc. Less than that is a seller’s market; more is a buyer’s market.

So, how do you use this information? First, there is no guarantee that every house will sell but, by doing the math, listing agents can better “position” their seller-clients to know what to expect. Same goes for buyer agents. Knowing market statistics and how they relate to reality will help. Of course there are other issues like pricing and marketing but it helps to know if a market, generally speaking, is moving fast or slow so that you can react accordingly when looking at specific listings. If a market is moving fast and you are not generating interest, your underlying problem may be quite different if your market was moving slowly. Some markets seem to defy adjustments to pricing and marketing. In those cases, you need a good rapport with your client because you may be working together longer than expected.



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