Absorption rate
Why it’s important
Carrying costs can push out your project’s break even point substantially. The market absorption rate offers a window into how substantial your carrying costs will be for your project. The absorption rate is calculated by dividing the total available space or available housing units by the average number of sales or space leased per month. In addition, absorption rates should also compensate for new construction and removal of existing space from the market, often due to physical depreciation. Absorption rates can also be used as a key indicator for developers considering new projects in an area.
Strengths/Weaknesses
Calculating residential inventory is an easier task than calculating commercial inventory. This creates more inherent risk in a commercial project. Due to less centralized records, absorption rate calculations can also overlook pre-sold homes and destruction of existing stock. In the event of a natural disaster, one’s knowledge of local conditions would enable a more thorough understanding of the impact on absorption rates. Absorption rates may also differ across different sub-geographies and price segments of the market. Therefore, it is critical to understand how substitute product may differ from the broader market absorption trends.
Resources
Your local multiple listing service will generally capture enough of the market to provide a clear view of absorption trends in the residential market. Various appraisal and brokerage firms also publish absorption rates online.
Total Inventory
Why it’s important
The number of housing units or square feet is a critical component in the supply and demand picture of a market. When combined with population, we get a good barometer of the supply/demand equilibrium or lack thereof.
Strengths/Weaknesses
Total inventory does provide a picture of deteriorating inventory or the pipeline of new inventory. It’s simply a snapshot of what’s in service today. The real value of this data is unlocked when used in tandem with population data; specifically projected changes in population. Any differential between these numbers can be compared with additions and subtractions from the total inventory to determine whether the future conditions will drive up prices due to undersupply or will drive prices down due to oversupply.
Resources
The US census conducts a study every other year called the American Housing Survey. It provides an estimate of total housing inventory, plus many other valuable data points for the professional real estate researcher.
Vacancy Rates
Why it’s important
Your vacancy rate will determine how long a space is empty between occupancies. Your effective vacancy rate will be determined by a number of factors, including: market conditions, pricing strategy, management policies and physical characteristics of the space. Key considerations during due diligence should include identifying the price at which rent revenue is maximized and degree to which the space is in demand for transient tenants. A transient tenant means more turnover and is generally less desirable.
Strengths/Weaknesses
While all properties have a “natural vacancy rate” (i.e. unoccupied time due to turnover), many of these factors are under control of the owner/manager. It’s important to understand which factors you have control over through effective management techniques and which must be acceptable as a condition of ownership. In fact, a high vacancy rate due to under-management can be a desirable characteristic to an investor, as that would indicate potential cash flow upside once they are able to apply their superior management acumen.
Resources
In addition to US census’ American Housing Survey, vacancy rates can be assessed by speaking with other owners and brokers in the area, as well as conducting research through the local MLS. Much can be uncovered about the vacancy rate for a particular property through the due diligence period.