Adapted from the July 2024 PREP Newsletter: "So What Does That Mean in Plain English?"
Among other important metrics often used when analyzing a real estate investment property, it is essential for an investor to review and understand the Absorption Rate (AR) (Occupancy Rate).
Don’t worry, no need to grab the sponge just yet ;).
The AR for real estate is very different from, say, the one for a roll of Bounty paper towels. In real estate, the Absorption Rate reflects the percentage of units in the property which are leased at a point in time. If a given property has 100 units and 80 of them are leased out, it has an 80% AR. As with all data which may be provided to an investor, it’s important to interpret it in an accurate manner. What does 80% tell me about the property? Is 80% high, low, ideal, or not?
Let's start with an underlying analysis of the metric. 80% AR can tell many different stories. It can indicate that the asking rent is too high and therefore not many people can afford or want to pay that rent amount. Perhaps the rents are fairly priced, but management is not doing a great job in securing new leases. Or maybe there are new-builds in the area offering a surplus of availability and tenants are running to the newer products. All of these stories are plausible and would require greater research to understand which is most accurate. Only then can a solution be presented to enhance the Absorption Rate.
Based on this one may think that the ideal AR is 100%, signifying that rents are being collected from every possible unit. But, maybe not. In this scenario, it is more likely the case that management is charging too little for rent and leaving “money on the table.”
The target AR for a hold period, or upon completion of the property’s business plan, is generally 93-95%. However, when an investor is looking to purchase a new deal, they may be looking for an opportunity with a lower AR, which would allow for a lower purchase price and the ability to execute a business plan and improve the AR. In other deals, an investor might look for a property with an already high AR, intending to temporarily lower it to allow more units to be renovated in a given time.
So all in all, what is a good Absorption Rate? The answer is…it depends. And only with experience and analysis, can one truly determine which rate is best for a specific investment opportunity. But hey, that’s where PREP comes in.
Written By:
Donny S. Steinberg
Director of Strategy & Innovation
