Last week we discussed How “building permit activity” Plays a key element in identifying Market position Analysis 3 today let’s discuss how Absorption Rates plays a role.
Absorption rate: (is simply the number of homes sold in a given month versus the number of homes for sale). For example if a market has 10,000 homes for sale and there is 1000 homes sold in a given month the absorption rate would be 10%. As absorption rates decrease the average days on market (DOM) increases. It is said that a market is balanced when the average market time (DOM) is 6 months
Why this is important to watch? This can be a barometer to where the market is heading.
As a market begins to cool down or slow in its activity we can see that the “average days a home sits on the for sale market” (DOM) will begin to increase. We will also see the number of homes for sale will begin to increase as well. As more homes for sale exist the percentage of homes that sell in a given month will slow down. (Decreased absorption rate) To the contrary as the markets heat up, the absorption rate increases and the DOM decreases.
Buy Low / Sell High: We all know this principle yet too many people do the opposite as they are running on pure emotions and they have thrown logic out the door. Understanding that when absorption rates are low and DOM is growing, we can determine the market is moving slowly and prices are low. This is when people are acting with emotions and everyone decides to sell. Here is where you the logical thinking investor can pick up incredible deals right now. Supply and demand is in favor of the buyer.
Time to Re-Position. As the average DOM decreases the absorption rates will increase. (More homes are now selling) Here we will see prices rising. DO NOT BE FOOLED. What goes up in value may come down. The idea is to re-position your investments before it peaks. I have found that when a market is selling homes with an average of 28 days on Market, this market is about reached its peak, Time to reposition, this may be a good time to do a 1031 Tax deferred exchange and purchase new real estate at the bottom of the next emerging market. Here you are positioned to sell for top dollar and sell quickly (fewer days on market) before the market makes it swing, stabilizes or begins to fall.
As you can see Absorption rates and days on market should play a big role in your buying decisions to help insure you are purchasing at an optimal time to maximize your investments.
Home pending is a looking glass into which way the absorption rates are heading and will be next weeks analyses study.