How many $300,000 four bedroom, four bath, three-car garage homes on a-half acre can you sell in the Northeast section of Your City, USA? Do you know how quickly these homes are being absorbed by the market on a monthly basis? Knowing the Rate of Absorption, or "AR," is a second-nature skill to the best builders and realty professionals, who know that sales are built not only on consumer demand but are also heavily influenced by market availability. The AR not only influences your marketing strategy; it can make the difference in the type of product you choose to build. A good real estate agent can help show you the way.

According to Realtor and motivational speaker Jerry Rossi , knowing the AR is the only true way to give an apples-to-apples comparison in new homes that have sold over the last 12-month period, or any time period you are seeking comparables. Once you have the number of units sold, you can divide by 12 or any number of months you choose to give you a per-month AR.

Here's a Jerry Rossi scenario that clarifies the importance of AR from the builder's and Realtor's perspectives.

"Let's do an AR search, proposing that 76 Same Size/Features New Home Units sold in your area over the last 12 months. Divide 76 by 12 and you get an AR of 6.33, or six and one/third homes sold every month. Now you go to a Realtor, and you say, 'I have 10 1/2 acre lots in the northeast section of Our City, USA. I'm going to build $300,000, four-bedroom, four-bath, three-car garage houses on them. Do you want the listing?' How do you think the Realtor will respond?

Most associates would leap at the opportunity. 'But wait,' you say. 'If 6.33 of these homes are selling monthly, then 10 will be sold in 1.6 months! I want the listing!' But a good agent will be more cautious. That person would think, 'Let's get realistic for a second. If you had plans and specs today, you still have to submit them for approval, get a permit to build, get bids on construction and supplies, find the money, have the lot prepped, etc. In most areas of the country, this takes four to nine weeks. It will then take you three to four months to get it completed! Hopefully, during that time, you'll have it sold. And that's just one house. What about the other nine? A big lesson in new home sales is to always look at the completion date.

A good agent will tell you that he/she will get back to you after doing a little research. Why? Because a good agent will want to evaluate his/her realistic chances of marketing that type of home. The first thing they will want to figure is the AR. To do this, the agent will examine three areas:

1. Standing (a.k.a. existing, finished, or for sale)
2. Starts (a.k.a. under construction)
3. Permits (permits are issued, but construction has not yet begun)

Where would an agent find this information? Most MLSs don't have all the new homes sold or for sale in their records because of two reasons: Many builders don't list in MLS, and many builders' homes are build-to-suit or pre-sold. The agent's job is then to search the city and county records to uncover permits, starts, and existing.

In our example, we search the records for $300,000, four-bedroom, four-bath, three-car garage on 1/2 acre in the northeast section of Your City, USA, and find 13 permits, 14 starts, and 11 existing for a total of 38 units in inventory. With this information, we can correctly use the 6.33 Absorption Rate (AR) to identify how many months supply of this type of home we have.

38 units/6.33 AR = 6 Month Supply of this specific kind of home.

Now everyone knows what they are dealing with. Although 6.33 of these homes are being sold every month, someone else is already building to fill that need, and when you add in the ten homes you want to build, it changes the paradigm to a more unfavorable AR rate. If you start this kind of home, chances are good that they would sit on the market for at least three months before they would sell; i.e., six month supply, minus three or more months to build, leaves three months supply left (that is, if no one else tries the market in the meanwhile). So your question should be - Is this the kind of home I should be building?

A good agent will then calculate what kinds of marketing efforts will be needed and will quickly conclude that no matter what marketing efforts they make, the absorption rate will work against a quick, profitable sale. This person will still work hard for you but will understandably have limitations on the amount of advertising, open houses, and other promotional commitments they can afford to do for you, especially at six months per home.

Better to rethink the type of home you have in mind and build something that will be more quickly absorbed by the market. Sometimes reducing or increasing the cost, size, and amenities of your homes can result in quicker and greater profits if you can build to a category that is in demand and underrepresented in the market.

How to find out? Do an AR search -- before you build -- and build to the needs and wants of the market."

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Published: January 14, 2000

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