What is absorption? Appraisers, brokers and other real estate professionals want to know how long it takes for a particular number of homes to sell in an area. For that answer, we look to the rate of absorption. Appraisers calculate this figure and assume that no other homes are being built during the particular period.
How To Calculate The Rate?
You may employ two formulas, depending on how you wish to express absorption in the appraisal process. To arrive at a percentage rate, you divide the number of homes sold in a month by the number homes available on the market. The formula looks like this:
Absorption Rate = Number of homes sold per month/Number of homes available for sale
Suppose your city has 2,400 homes listed for sale. If an average of 300 have been sold per month over some period of time, you calculate the rate as follows:
Rate =300 homes sold/2,400 for sale = 0.125, or 12.5 percent. That means purchasers take 12.5 percent, or just shy of 13 out of every 100, homes for sale each month.
Remember that absorption tells appraisers how long it takes to sell a given number of homes on the market. And that helps determine the value of your home. You can use this formula to calculate the months:
*Absorption Rate =Number of homes available for sale/Number of homes sold in a month
Using our above example of 2,400 homes for sale and 300 sold on average:
Rate =2,400 homes for sale/300 sold per month =8 months to sell all the homes on the market.
How Do You Get Sales Information?
The Multiple Listings Service (MLS) provides real estate brokers and appraisers details on the number of active listings and sales in an area. Appraisers can access MLS through a membership with the National Association of Realtors (Realtor.com).
Why Do We Use Absorption In Appraisals?
Appraisers render opinions of value to aid buyers, sellers, agents and lenders. The buyer (or buyer’s agent) wants to avoid overpayment, while the seller or seller’s agent guards against underpricing the home. Banks and mortgage companies require that the subject property appraise at a particular value as a condition of the loan. Fannie Mae and Freddie Mac have set loan-to-value ratios in which the amount borrowed cannot exceed a particular percentage of the value.
What Goes Into An Appraisal Generally?
Appraisers typically consider specific aspects of the home in arriving at value. These factors include the home’s square footage, the number and types of rooms (bedrooms, bathrooms, bonus rooms, kitchen, living room or den); the floor plan; landscaping, and colors and styles of cabinets, flooring and paint on walls. Whether the home has cracks in the ceiling, foundation or driveways and the condition of the roof also influence appraisals.
Uniform standards control how appraisers perform their work. Depending on the lender, though, your appraisal may have stricter requirements. Commonly, loans guaranteed or granted through the Federal Housing Administration (FHA) or Veterans’ Administration (VA) may require appraisers examinations and inspections not needed for a conventional loan.
Why Do Appraisers Use Absorption?
Supply and demand help set the prices of most things in the economy. Real property values are not exempt from the forces of supply and demand. All other things being equal, prices (and values) rise with higher demand or lower supply. With lower demand or greater supply comes lower property values. These principles underlie the theory of absorption in regards to appraisals.
What Does The Rate Tell Us?
With the calculations used in absorptions, appraisers and other real estate professionals can tell you if your real estate market is a “buyers’ market” or “sellers’ market”:
Buyers’ Market: In a buyers’ market, the supply of homes outpaces the demand. You will likely find that homes sell more slowly in such a market. With more sellers than buyers comes lower home prices across the board. Buyers may even exact certain concessions from sellers to motivate them, such as paying for or sharing in closing costs.
A rate south of 15 percent generally signals a buyers’ market. In our illustration above, you would find yourself in such an environment.
Sellers’ Market: You will experience a sellers’ market with rates greater than 20 percent. A sellers’ market translates to higher home prices because demand exceeds the supply of homes. In such a market, homes tend to sell more quickly.
To achieve a sellers’ market with 2,400 available homes, you would need to see more than 480 homes being sold per month.
What Affects Absorptions In Appraisals?
The conditions that affect the absorption rate and the supply and demand for homes range from the local or regional to even global. On a local scale, an influx of employers and accompanying job opportunities, quality schools or recreational and entertainment opportunities can drive demand upward. You can expect elevated demand for real estate in scenic areas such as beaches, mountains and lakeside communities.
Lending strongly influences supply and demand. Higher interest rates, stricter underwriting standards, weak economies characterized by high unemployment and low wages suppress loans granted by banks and mortgage companies. Fewer mortgages mean fewer home buyers and lower prices. Conversely, lowering interest rates help spark the demand for the loans that fund home purchases.
Why Might Lenders Be Interested In Absorption Rates?
Mortgage companies and banks rely on accurate or reliable appraisals and absorption rates to guide decisions on the amount and payment terms of loans. To that end, the lender does not merely rely on a negotiated or agreed upon price as proof of the value.
Factoring supply and demand into an appraisal helps banks catch potential overpricing. That is, the home might actually not be worth what solely the buyer and seller think or have selected as the price. Where the buyer and seller may have narrowed their focus to the appearance and condition of the home, an appraiser (and the lender) look at how quickly homes sell in a community. If an appraisal seems too high for the overall demand for homes in the area, an appraiser might offer as explanations upgrades to the home or interest from other prospective buyers. The latter may be especially convincing depending on the prices in those offers.
Whether you need an appraisal for a mortgage or to know if you might be under pricing the home or a seller is overpricing it, contact our team for professional appraisal services. We offer free quotes when you fill out a request form or by emailing us directly.