As you begin to analyze markets, you will encounter the term absorption. Knowing what it means and its importance is essential to your understanding of the subject market.
What is absorption? Absorption is a metric used by multi-family investors to measure tenant demand. It is used to describe the extent to which multifamily units are being leased or exited. Put simply, if there are 100 new two-bedrooms in the local market, absorption is 100 for that unit size. Net absorption, however, is a more useful measurement because it measures additional leases minus units that are no longer occupied.
Positive Net Absorption is when more units overall are leased than are no longer occupied. This is a positive sign in the market. For example, in the local market for 3-bedroom units, if 100 new units are occupied and 15 units are no longer occupied, there is net absorption of 85 units.
Negative Net Absorption happens when more units are no longer occupied than are leased. This would be the opposite of the example above. Let’s say in the same market, but for studio apartments, 15 new units are occupied and 100 units are no longer occupied, there is net absorption of 85 units. This could be a negative sign, or at least a negative indicator, for your market or investment class due to a net loss in occupancy.
As you review market reports, understand the absorption trends. What you will find is that absorption can vary by class, unit size and neighborhood.
For example, in a particular submarket, studio units have negative absorption while two and three bedrooms have positive absorption. This may lead us to the conclusion that there is less demand for studios and a growing demand for larger units.
Another example is the difference observed absorption trends by building class or neighborhood. Class A apartments in high-growth areas (growing employment, population growth, etc.) would likely have higher absorption than Class C or D properties in less desirable neighborhoods due to higher demand for living in the former and lower demand in the latter.
Of course, many market variables must be taken into account and one should not conclude that absorption is attributed to any single factor. However, understanding absorption rates and trends is a great start to understanding the supply and demand for living in your target market.
Check out more common real estate investing terms on our resources page!
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