One of the simplest ways of assessing the real estate market is to check the absorption rate, often called the months of inventory.
In short, it tells you the pace of home sales (beyond the simpler days on market). It informs you:
- if you’re buying, whether or not you need to hurry or if you can take your time!
- if you’re selling, this figure tells you what the odds are of your success in the next month. That could impact your selling strategy.
What is the months of inventory, or the absorption rate?
The absorption rate tells us how quickly the current inventory will be absorbed, or sold off, if sales continue at the same pace and no new inventory were to be added.
The absorption rate could be measured in days, weeks, months, years, or decades – but the most common is the months of inventory. It’s really two data points in one: the available inventory and the number of sales in a particular period of time.
If this is hard to picture, consider a bathtub. If the tub is draining, how long will it take until the water is gone if the faucet is left off and if water continues to exit the tub at the same rate? That is the pace we are considering for homes for sale.
When homes are selling fast, in 30 days or less, often the data is described as days of inventory rather than weeks or months.
What is a fast absorption rate, and what does that mean for home sellers and buyers?
A balanced rate of sales suggests that neither home sellers or home buyers have a real advantage over the other. In the United States, anywhere from 4 – 6 months is considered balanced. Less than that is a seller’s market, and more than that is a buyer’s market. The lower the number, the hotter the market.
In Silicon Valley, though, it’s almost never as high as 4 months – though it can and does happen sometimes.
For us, anything under 2 months is a hot market, and anything under 1 month is a super hot seller’s market.
Here’s a graph displaying the absorption rate for houses in Santa Clara County between January 2005 and now. The highest absorption rate was 14.2 in January 2008. It fell quickly from there with the next month at 12.4, then 10.1 in March, and eventually settling in at around 6-7 months of inventory for a period.
For home sellers, it is crucial to understand this number, as it correlates to their odds of success in selling a home in any given month. If there is 14.2 months of inventory, there’s a 1 in 14 chance of selling that particular month.
For home buyers, the same is true: if the number is high, the market is soft and you will have good odds of success if you write an offer – generally! Lowballing may not work.
The opposite is also true. When the months of inventory is low, the sellers’ odds of success are high and the buyers’ odds of success are lower.
How to calculate the rate of absorption
You can check the rate of absorption at any point in time, it does not have to be a full calendar month such as all of August. The math is simple: you simply divide the number of listings by the number of closed sales for the month (often 31 days is better than 30 for the month since usually there is some delay in reporting closed sales.
If there are 50 listings for sale (active, not under contract or pending) in a given area and in the last month (or 31 days) there were 10 closed sales, then you are looking at 5 months of inventory. That would be a strong buyer’s market.
Right now in San Jose there are 598 single family homes for sale (houses and duet homes – duets are not the same thing as duplexes). In the last 31 days, 407 houses sold and closed escrow. 598 divided by 407 = 1.47 months of inventory.
If we compare our mid-month absorption rate to the closed data of the last month or two or three, we will have a better sense of the trajectory of the market. A moment ago I pulled the San Jose single family home absorption rate from the MLS by month:
We are only 9 days into the new month, and homes that are closing today probably aren’t showing as closed yet, so we acknowledge that the picture we have of the market could change. Even so, we see that in August San Jose had 1.6 months of inventory, and for the last 31 days as of now, the months of inventory is 1.47, so it appears that the market is tightening further – moving more into the seller’s favor.
The real estate market has seasonal patterns, though. Often the week before and after a holiday are slow for new listings and new sales. This could look very different in 2 weeks.
What the absorption rate does not tell you
This is a fantastic data point, but it won’t tell you what your home will sell for, or how much you’ll have to bid to get it. There are multiple factors at play. Normally when there are multiple offers, properties sell for more than list price. But this is not always the case and you cannot count on it.
Across Santa Clara County right now, we have both a short absorption rate and falling prices in most areas.
Here’s a table from my monthly RE Report for Santa Clara County. DOI stands for the Days of Inventory.
Mountain View is one of the stronger markets right now. In August there were 17 sales and although the number of sales were off 39.3% from a year ago, prices are still up and homes are selling on average of 101.1% of list price. The days of inventory is 32, not much more than a month, so a pretty hot market. We aren’t seeing the overbids from last Spring, but it’s still in the sellers’ favor.
Saratoga’s days of inventory is at 42 and prices are still up compared to last year, but the sale price to list price ratio is down at 95.6%. Saratoga has several school districts and a broad range of sale prices, so those factors could be at play.
The months of inventory indicate how tough or easy it is to buy a Silicon Valley house (on our main blog)