Revised framework for net absorption rate
Net absorption is defined as the change in a market’s occupied stock during a particular time period. Net absorption and the net absorption rate is a useful figure for understanding changes in demand in a real estate market. This formula can be used as a framework for understanding net absorption:
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.
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)
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.
Different framework for net absorption rate
Net absorption rate is that percentage of previously vacant stock now occupied (over a specific time period).
It is made up of two parts, measured over a period of time:
- Net absorption (OR, option 1 adjusted for changes in stock supply¹), and
- The total of commencing vacant stock (OR, option 2 adjusted for changes in stock supply¹).
A simple example: if a node has 200K sqm of vacancies, and 25K sqm of that vacant space is let over 6 months, the absorption rate for those 6 months is 12.5% (25K sqm / 200K sqm). At the current absorption rate, assuming no changes in supply, all vacant space should be occupied within 4 years (6 months / 12.5% = 48 months).
Assuming supply remains constant:
- A positive net absorption rate predicts increasing prices for owners or tenants.
- A negative absorption rate means that more stock is being released into the market. This increase in supply will reduce asking rentals.
Easy example expanded
A property has 80K sqm of rentable area or GLA, with 10K sqm of that being vacant.
What is the property’s net absorption rate over a 3 month period given the following events?
- 5K sqm of vacant space is taken by new tenants moving in
- 3K sqm of space is released by tenants who move out
- 1 tenant, occupying 10K sqm renews for 12K sqm (taking up an extra 2K sqm)
- A tenant, occupying 8K sqm renews for only 2K (releasing 6K sqm)
- One tenant sublets 5K of their space
With 2K less space occupied, the net absorption for the 3 month period is a negative 20%.
Calculation: ( 5K sqm new space let – 3K sqm released + 2K sqm positive renewal – 6K sqm negative renewal (and sub-let is ignored) ) / 10K sqm vacant.
More complex example (catering for changes in stock supply¹ )
At the beginning of 6 months, a node has 900K sqm of office rentable area or GLA, with 100K sqm of that office being vacant.
During the analysis period
- 80K sqm of new office space is built. 30K sqm of that office space is pre-let, the balance of 50K sqm is not.
- 10K sqm of vacant office space is repurposed to residential and retail
- Net office absorption, excluding the pre-let space, is positive 25K sqm. I.e. 25K sqm in net deals, other than the pre-let, were done during this period.
Net absorption is positive 55K sqm.
Calculation of end vacancy: 100K sqm start + 80K sqm new space – 10K repurposed – 55K sqm net office absorption = 115K sqm end vacancy.
The commencing office vacancy was 100K sqm, the end vacancy was 115K sqm.
What is the node’s net absorption rate for that office over a 6 month period?
Calculation A: 55K sqm net absorption / ( 100K vacant sqm + 80K total sqm built – 10K vacant sqm removed ) = 60 / 170 = positive 35.3%. Challenge: but vacancy has increased by 15K sqm.
Calculation B: 55K sqm net absorption / ( 100K vacant sqm + 50K vacant sqm built – 10K vacant sqm removed ) = 60 / 140 = positive 42.9%. Challenge: but vacancy has increased by 15K sqm.
Calculation C: Negative change in office vacancy of 15K sqm / starting vacancy 100K = negative 15%. Challenge: but this ignored the significant trend of positive net absorption of 55K sqm.
Calculation D: (Going strict on the previous vacancy space definition) Previously-vacant occupied 25K / 100K previous vacancy = positive 25%. Challenge: this completely ignores the changes in supply.
Acid tests:
- If a positive net lease absorption rate, the total amount of vacant space should have decreased from period start to end
- A positive net absorption rate should reduce the vacancy rate
- Other?
Applications of net absorption rate
Instead of just a single property, the net absorption rate can also be measured across either:
- An area² (i.e. is this node seeing demand pressure and supply constraints?), or
- An occupier’s leased portfolio (is more space being taken up than is being let go?), or
- An owner or property manager’s portfolio of owned or managed properties
Other information related to net absorption rate
Where properties are still in construction / planned / under-renovation, leasing deals only count for gross or net absorption on the actual occupation date. Note: Because the delivery date and occupation date are the same, this should not effect the net absorption rate.
² Property is a non-homogenous asset class. For meaningful nodal comparison and analysis, an area should be defined by (at minimum) criteria such as geography, property category, and ideally grade (ideally objective). Further, more meaningful analysis should extend to the properties’ sub-category (e.g. low-rise / high-rise office), size of vacant pockets (e.g. non-divisible vacancies within the 1K to 5K sqm range), even property attributes (all logistics warehousing with height to the eaves greater than 8m, or all logistics warehousing with coverage < 60%)
