January Q&A: Absorption Rate

Lane Hornung wants you to imagine a big pond.


But instead of filled with fish, the pond is filled with homes that are for sale.

And there is a narrow stream feeding the pond with new home listings.


On the shore, consumers, with their Realtor-guides, are fishing for homes. Their bait might include equity from their existing home and a letter from a lender pre-qualifying them for a mortgage.


As the homes leave the pond, they are “absorbed” by buyers.


Homes were being absorbed so fast in the Denver-area, that there was only a six-week supply of unsold homes on the market at the end of 2014, according to REcolorado (formerly Metrolist.) Similar trends are taking place in other strong markets, such as Northern California.


The absorption rate is the subject of this month’s question and answer session between Hornung, CEO and founder of 8z Real Estate, and John Rebchook, of InsideRealEstateNews.


John: Lane, I like your pond metaphor. Can you describe the concept of the absorption rate for us?


Lane: People will do it differently. I take the number of homes for sale during a specific time period, such as one month. Then, I divide the number of active listings by the number of sales of homes.


John: What does that tell the consumer?


Lane: I think the easiest way for a consumer to understand is that it gives us months of inventory. That is, if no new homes were added to the market, and the absorption rate was the same, the months of inventory tells you how long to sell all of the homes – empty the pond, so to speak.


John: What do you make of only six weeks of inventory?


Lane: That is incredible. To put that into perspective, six months of inventory is generally considered a market in equilibrium. That is, it doesn’t favor either the buyer or the seller. And, frankly, some hot neighborhoods have less than a six-week supply. To call this a seller’s market is an understatement.


John: Getting back to your pond analogy, new homes are entering the market all of the time.


Lane: InsideRealEstateNews recently published a graph showing how new listings and homes placed under contract crossed. In fact, there were even more homes placed under contract than new listings. Sales also out-paced the active listings. What that means the pond isn’t getting replenished. In fact, some of those homes have sunk to the bottom of the pond. Given how strong the market is, the homes at the bottom of the pond are likely grossly over-priced. If you removed those listings from the equation, you have even fewer homes on the market.


John: Lane, what do you see ahead in 2015?


Lane: More of the same. I don’t see anything that is going to boost the number of active listings in the near future. Clearly, we have a supply problem, not a demand problem. That means homes are going to be absorbed quickly and at higher prices.


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