Every market and class of multifamily performs a little bit differently than the others. There are times when all classes are in sync and there are times when all classes are performing rather differently. One of the key aspects of multifamily investing is determining if a property or location will have strong rental demand/ occupancy. Preemptively looking at absorption trends is a great place to start to determine this.
Absorption vs Absorption Rate
Beware, there is a difference in talking about absorption and the absorption rate. Absorption refers to the net change in the total number of apartments leased. The absorption rate is the proportion of newly completed units that are or have been leased, usually over a given period (such as 3 months).
What is absorption? Absorption measures rental real estate demand. Absorption indicates if a market is "hot" or "cool" by measuring the change in occupancy. Absorption is calculated as follows
Total # of Units Leased / Total # of Units Available for Lease = Absorption
Keep in mind that there are constantly units being leased and vacated simultaneously. Put simply, absorption measures the flow of leasings and vacancies to measure demand.
Absorption is especially critical for developers who are intending on introducing new rentals in a market. If a developer is introducing 150 new units into a market, and there is strong positive absorption, they can rest assured that the property will lease up quickly. However, if they introduce those units in a negative absorption market, the units may be vacant longer and or have to offer concessions.
Absorption is local and also changes for different classes. For example, say we are looking at the Philadelphia market. There may be a positive absorption in class C two-bedroom apartments, but there may be a negative absorption in Class C studios. This would mean that there is an increased demand for two-bedroom apartments in this market and a decline in demand for studios.
Units Leased: 2605
/ Units Available: 2054
Tip: When there is high positive absorption (over 20%) this is an indicator that there is strong demand and therefore an ability to increase rents.
Absorption is an extremely helpful metric when evaluating a market. It gives insight into the demand trends and allows you to formulate a business plan around the hard data. It's important to evaluate the longer trends to determine where the market is heading and not too short of a time frame.