Many research focused home buyers looking to make a smart home buying decision will often invest a lot of their time studying the average price per square foot in the condo building they’re interested in. There are two main problems with focusing exclusively on average prices. Firstly, prices are a lagging indicator which means that the change in prices in a building today reflects underlying events and imbalances in the building over the past 6-24 months. Furthermore, prices today often mask what is really happening in a condo building.
In my recent post I wrote titled How to Avoid Buying at the Peak of a Real Estate Bubble I offer a real life example of how we were able to see the signs of a declining housing market in Phoenix Arizona two years before prices actually fell. In that example, prices remained relatively constant for two years while the inventory of homes available for sale soared - a sign that supply exceeds demand.
A similar approach can be used to compare one condo building to another. Condominiums are their own mini communities that can and should be analyzed independently from other buildings. It’s not uncommon to have two neighbouring buildings with very different investment potential.
When you’re trying to decide if a condo building is a good investment you want to ask one important question: out of all the condos that were listed for sale in that particular building over the past year, how many actually sold?
We call this number the absorption rate. An absorption rate of 100% would tell us that every unit that was listed for sale actually sold while an absorption rate of 0% would tell us none of the units sold (and yes, there are condos with a 0% absorption rates).
The absorption rate is an important metric because it gives you an indication of the balance between supply and demand in a building. A high absorption means demand is strong and may even exceed supply which generally results in higher prices. A low absorption rate tells us that the supply of units in that building exceeds the demand and usually results in a decline in prices.
The absorption rate today tells us which direction prices are likely to head in the future.
Let’s take a real life example to highlight how the absorption rate can differ in two actual condo buildings. 32 Davenport is a Yorkville condo that was completed in 2015 and has just over 200 units and 18 Yorkville is a 10 year old building in the same neighbourhood with just over 300 units.
The chart below shows the absorption rate for each building.
This chart shows that 72% of condo owners who tried to sell their unit at 18 Yorkville were successful compared to only 12% at 32 Davenport. Put another way, 88% of condo owners at 32 Davenport were unable to sell their unit when they put it up for sale. Not a great stat if you’re an owner at 32 Davenport.