What is the general concept of absorption in CRE
In the analysis of commercial real estate (CRE) performance, several indicators are used to show changes in demand. Many of these metrics are absorption-related. Commonly (mis-) used measures of absorption include gross absorption, net absorption, and average or normal absorption. Such misuse is due to the clarity of the definition, versus the application of the metric.
Therefore, it is helpful to set forth accurate definitions of the different types of absorption.
What is gross absorption
For practical purposes, gross absorption (👈 more detail here) is defined as the total lease space occupied during a particular period.
Gross absorption looks only at new leases signed, and will always be a positive value. For net changes in lease space signed, please see net absorption.
For practical purposes, leased space is used as a proxy for occupied space (this doesn’t satisfy the stricter definition, which deducts shadow space from the lease space signed).
What is net absorption
Net absorption (👈 more detail here) is defined as the change in a market’s occupied space during a particular time period.
This is a useful figure for understanding changes in demand in a real estate market. This formula can be used as a framework for understanding this concept:
Net Absorption = Occupied Stock at End of Period – Occupied Stock at Beginning of Period
where
Occupied Stock at End of Period = Total Market Stock at End of Period * (1 – Vacancy Rate at End of Period)
Occupied Stock at Beginning of Period = Total Market Stock at Beginning of Period * (1 – Vacancy Rate at Beginning of Period)
So, in order to calculate net absorption, one would need to know the total market stock (in a defined real estate market or sub-market) at the end and the beginning of the specified period, and one would need to know the vacancy rate (of the same sub-market) at the end and beginning of the period.
Net absorption gives developers an idea of the opportunity to meet demand in a market, however, it is not enough to know the extent of net absorption to get a proper understanding of the strength of the market; it is also important to understand why demand is high – for example, is it because of strong employment or population growth or is it because firms are ‘banking’ (or hoarding) leased space because they expect rents to rise in the near future? This comes with an active understanding of the sub-market.
For practical purposes, leased space is used as a proxy for occupied space (this doesn’t satisfy the stricter definition, which deducts shadow space from the lease space signed).
What is the net absorption rate?
Considering the formula above for net absorption, the net absorption rate (%) would show how much the total occupied stock in the market has changed relative to the total occupied stock at the beginning of the period:
Net Absorption Rate = ((Occupied Stock at End of Period – Occupied Stock at Beginning of Period)) / (Occupied Stock at Beginning of Period)
where
Occupied Stock at End of Period = Total Market Stock at End of Period * (1 – Vacancy Rate at End of Period)
Occupied Stock at Beginning of Period = Total Market Stock at Beginning of Period * (1 – Vacancy Rate at Beginning of Period)
Because it shows the relative change in net absorption, the net absorption rate is even more useful than simply knowing the net absorption, and can be used to compare the level of demand in different sub-markets.
A more in-depth discussion of net absorption rates can be found here.
What is average/normal absorption?
This is an estimate of the average net absorption over a historical period, usually a long one, if the data allow it.
Net absorption typically fluctuates a lot over a given period, and therefore, normal absorption (an average) is not a good basis for making predictions for net absorption for the years ahead.
