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Absorption Rate - Quantifying the Housing Market for Sellers
"But I know my house is worth more than that!" Virtually every real estate agent has heard that before. And there are a lot of reasons (not just greed) that homeowners often think their houses are worth more than they actually are - given the current market. So you try to explain that there are eight months inventory for that type of house in the current environment. Their eyes glaze over.
The National Association of Realtors suggests using an Absorption Rate Figure, which quantifies the current market for the seller in simple terms. It also has an added advantage of alerting the real estate agent to recent changes and trends in the marketplace for a particular type of house, if the real estate agent takes the time to update his data monthly.
Well we intend to make it easy for you to do exactly that! Before we get to the fancy Online Absorption Rate Calculator, designed to rival the popularity of our Real Estate Contact Calculator, let us explain how to manually calculate the figure.
Let's presume your seller has a 3BD/2BA, 1800sf home in the Coeur d'Alene School District. His house was built in 2004. You determine that a reasonable search criteria that a potential buyer might use would look something like this:
3BD/2BA
1600 - 2000 sf
CDA School District
Built in 2000 or later
First you want to determine the number sold over the past year that meet the potential buyer's search criteria. So you conduct your search and for this example we will say that 52 homes matching that specific criteria were sold over the past year. Take that number and divide it by the number of months in the test period (this time 12 months)
52/12 = 4.33 monthly rate
Now you wish to alter your search criteria to list currently active houses that meet that same criteria.
For this example we will say you find 36 active listings matching the above criteria.
Now take this number and divide by the monthly rate:
36/4.33 = 8.31
This means that the Absorption Rate is 8.31 (or months of inventory specific to this type of house)
NAR says that 6 is normal. Anything less than six is a hot market and anything greater than six indicates a slower than normal market. You can now give the seller a simple number, 8.31, and indicate that this is 38% slower than normal, according to NAR. That helps the seller understand why he must be more competitive in the marketplace.
As a Realtor you can provide true value to your clients by running the absorption rate figure when the house is listed, and then rerunning the exact same criteria every month the house is listed in order to track the trend in the rate. You may also run a twelve month, six month and three month report at the time of listing to try to determine how the market has been changing over time.
Obviously it is important that the criteria is the same in each AR report or you will be comparing apples to oranges and getting worthless results. Furthermore we suggest obtaining the criteria from a consumer based search tool, such as the housing search tool provided by Realtor.com or Tomlinson North Idaho if you are interested in North Idaho Real Estate or Spokane Area Real Estate. We make this suggestion because the search criteria needs to be the type that a typical consumer would use in his search. However, the data must also come from the same database or it may again become unreliable. For this reason we suggest using a consumer based search engine to select the criteria, but actually run the criteria through the most appropriate MLS to get both the inventory figure and the already sold figures.
BUT WAIT! Here is the real gold of the Absorption Rate figure!
If the number of houses available were only 26, then the Absorption Rate would be 26/4.33 = 6 - a normal market! But how can you modify supply and demand to achieve this number? Well unless you are playing a real estate computer game, you cannot. What you can do is look for pricing criteria that would return a number closer to 26. Let's presume that when you put in a price cap of $300,000, only 25 active listings are returned. That's pretty close to the 26 number we are looking for, and $300K is a reasonable figure that a searching buyer might enter (as opposed to $302,458 which might return exactly 26 properties, but no buyer is likely to ever enter that number!)
But now that you have modified your search criteria you need to go back and get the real figures for sold houses over the past year with the $300K cap in place. Lets presume only 42 met this new criteria. Now we have:
42/12 = 3.5
25/3.5 = 7.14
Still not "normal" but instead of a number 38% higher we now have a rate that is only 19% higher.
Now, for our last bit of tweaking. Let's drop the price to $290,000 . If we see that there were 40 sold over the past year and 21 currently available we would get an absorption rate of 6.3, darn close to "normal." If we take a look at the actual sold price as a percentage of the list price and see that the figure is 99%, that would seem to indicate that houses were properly priced over the past year for the existing marketplace. If we further see that the average days on market were 136 then we can again see that the rate at which these "properly priced" homes will sell is roughly average. If our original CMA suggested a figure close to $290,000 as a listing price we might consider listing the home at $289,900.
Suggested Steps:
One - Conduct a normal CMA to arrive at a listing price or range for the home
Two - Identify a typical consumer based search criteria that would encompass your proposed listing
Three - Use the criteria in step two to obtain a 12 month Absorption Rate figure
Four - If desired, conduct a six month and three month AR analysis to help identify the trend
Five - Re-run the twelve month AR criteria with a price cap close to, but above your CMA price. Additionally you will need to rerun your numbers on the sold side and use this price in the "Listed At" field. (A consumer that searches for a home but limits himself to a cap of $290,000 will not see homes listed at $300K, so the ones that sold at $300K are immaterial to this new search)
Six - See if "tweaking" the CMA price slightly makes a difference in the number of available homes. Ensure that you only use prices that a consumer might enter when searching for a home. Do not fall into the trap of tweaking price until you get the best AR number. A small amount of price adjusting may help you determine a better list price. Extensive and substantial adjustments far from your original CMA may yield the best AR but will not yield the optimum list price.
Seven - Look at the houses sold under the step six criteria and determine the sold:list percentage. A number of 97% or higher helps to substantiate the proposed list price determined in step six.
Eight - Check that all search criteria are such that they are likely to be used by most consumers looking for that type of house. Confirm or deny that the list price determined in step six is a good list price.
Nine - make your best recommendation to your client on listing price.
Ten - rerun the AR figures for twelve months using your actual list price. Then, each month thereafter run the exact same criteria over the most recent twelve months and track the AR numbers to see which way they are headed. If you believe a viable trend has developed you can use the data to support any suggested change in price to the homeowner.
Not only are we able to use the Absorption Rate to easily explain the market as it relates to the sellers specific property, but as agents we can use this figure to help price the home and to recalculate the rate monthly to see which way the market may be trending - again specific to the sellers home. Using these tools wisely can tremendously aid the resourceful agent in getting homes sold in a reasonable time frame in virtually any market!
CAUTION: As of yet no computer program, data algorithm or online calculator has been invented which can replace a real estate agent's brain! The Absorption Rate, the Absorption Rate Trending and the use of "norming" the rate in order to properly price homes are all tools to be used by an agent with brain securely fastened in place!
If you blindly follow a computer program you will find plenty of instances where exceptions (such as those where median and average are significantly different, or search criteria is too specific or not specific enough) will result in improperly priced homes. We believe the best method for using these tools is to conduct a thorough CMA (competitive market analysis) as you have been trained to do. Then, after completing that CMA and arriving at a reasonable price picture, consider using the Absorption Rate methods to verify your CMA analysis.
The number and magnitude of potential errors using this process are far beyond the scope of this article. Any agent must use his best judgment at all times instead of relying solely on a computerized method. You would not use a hammer to fix every problem in your home. Likewise you must use this tool when appropriate and choose to use other tools when this tool is not appropriate. No tool should ever replace your most important tool - your brain.
Note: This is not an offer to buy or sell properties in Idaho or any other part of the country. The information in this article is merely an opinion on the real estate market. It uses data from the Coeur d'Alene Association of Realtors which is believed to be accurate but is not guaranteed. No statement within this article should be viewed as a suggestion or statement to buy or sell real estate for investment purposes or any other purpose! The data was garnered from sources believed to be accurate but is not guaranteed. The 2008 real estate recovery prediction is a forward looking document which is only an opinion.
