Absorption is the quantity of real property (for commercial space, usually shown in square footage, and for residential space in number of housing units) sold or rented per time period. Absorption may also be defined as the net change of newly occupied space during some time period.
Reliable absorption estimates are essential when evaluating whether to invest in proposed projects, or when evaluating the future demand for existing space. The time required to rent or sell a property, and the revenue obtained during this time determine the cash flows to the project. This, in turn, is an important component used to determine project value, collateral value, ability to make payments to lenders, and financial feasibility.
Example Absorption Calculation
This, of course, is a historical look. What is more important, but also more difficult, is to project future vacancy rates to evaluate a potential investment.
Capture rate is a related topic. It is defined as the percentage of the absorption that will be seized by a project. For example, let's say a project is a 100-unit apartment complex, and the absorption rate is 300 units per year. If the owner wishes to be at full occupancy (say, 90%) in 30 months, the project must fill 3 units per month (36 per year). Hence, the required capture rate is 12 percent (36/300).
If an investor is evaluating an existing project, the analyst may simply report that the project represents 33 percent of the annual absorption rate (100/300). This gives the investor some information regarding the health of the market as it relates to the size of the project. In other words, it represents a risk measure.
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