Months Supply of Inventory (MSI) and Absorption Rates in Real Estate

I love real estate statistics. I got a math degree from the University of Texas, so I could make a career of real estate stats. In this blog, I’ll keep things relatively simple.

In efforts to improve the statistics I present you, I am beginning to mine for and calculate absorption rates and months supplies of inventory for you. These stats are important because they reflect how a market is doing. They also help savvy buyers and sellers establish and meet their goals.

Absorption rate – the rate at which real estate is sold, or absorbed, in a specific area

I calculate absorption rates in terms of homes sold per month. Thus, for South Lake Tahoe the absorption rate is the number of homes sold in the last year, 341, divided by the months in a year, twelve. 28.4 homes are sold per month in South Lake Tahoe. This is the absorption rate. (Feel free to skip the rest of this paragraph.) Some people like to express absorption rates in relation to the amount of inventory. Our inventory in South Lake Tahoe is 476 homes. Thus, 28.4 homes is 5.97% of the inventory; so the absorption rate is 5.97% of the inventory per month.

Months supply of inventory (MSI) – an estimation of how long it will take for all the market’s homes to be sold, or absorbed, based on how many homes are currently on the market and the rate homes have sold in the past (absorption rate).

This is pretty simple. If 28.4 homes are sold per month in South Lake Tahoe, how long will it take to sell 476 homes? Divide homes by homes sold per month (476/28.4 = ???). It will take 16.76 months to sell all the houses. This is the months supply of inventory (MSI). You may now be asking, “Who cares? New homes are listed all the time. You’ll never sell the entire inventory in South Lake Tahoe.”

This is true. MSI is simply used to compare the size of an inventory to the rate of sale. This is very important. MSI is a great indicator of how balanced a market is.

MSI less than 5 months = seller’s market
MSI equals 5-7 months = balanced market
MSI greater than 7 months = buyer’s market

These guidelines are not fool-proof. Notice in the table below there is a 6.7 month supply of inventory in the sub-$300,000 price band in South Lake Tahoe. Any seller in this price band will tell you it’s not a balanced market. The buyers continue to call the shots. The MSI stat was skewed in this price band by desperate sellers, especially banks, who bent over backward in the last year for buyers. Thus, the absorption rate was increased, which decreased the MSI.

So how can these stats help you? I’ll preface the answer by saying that no mathematical model can be used to determine what will happen in real estate. There are way too many factors involved. That having been said …

For sellers, these stats will tell you how much competition you have. Let’s consider a seller with a $1,500,000 listing in South Lake Tahoe. With almost 33 months of inventory, he better think about some serious price reductions if he wants to sell soon. The seller with a sub-$500,000 listing (6.7-13.3 months of inventory) should also think about a price cut. However, there is a greater chance he’ll get lucky and find a buyer who loves his home and qualifies for a loan.

For buyers, MSI will tell you how negotiable sellers may be in different markets. If there are 3.5 months of inventory in Bangladesh and 10.2 months of inventory in Baghdad, the sellers in Baghdad will probably be more negotiable.

If you have questions about these statistics feel free to comment, e-mail me (dkondo@chaseinternational.com), or call me (530-545-1831).

South Lake Tahoe real estate statistics as of 7/1/2008

Price Range
Active Listings
Absorption Rate in sales/mo. (% of inventory) Months Supply of Inventory
$0 – $300,000
32
4.75 (14.84%)
6.7
$300,001-$500,000
173
13.00 (7.51%)
13.3
$500,001- $750,000
127
6.33 (4.99%)
20.1
$750,001- $1,000,000
68
2.50 (3.68%)
27.2
$1,000,001- $2,000,000
57
1.75 (3.07%)
32.6
$2,000,001 and up
16
0.08 (0.52%)
192
Posted on July 7, 2008 at 5:39 pm
Drew Kondo | Category: Statistics | Tagged , , , , , ,

3 responses to “Months Supply of Inventory (MSI) and Absorption Rates in Real Estate”

  1. York says:

    your blog is very helpful to me. I’m a research editor/translator focusing on China’s real estate sector. 🙂

  2. E says:

    I think your absorption rate (month supply of inventory) calculation is very flawed…

    Two ways I know of calculating months supply of inventory:

    1. #Actives / #Pending e.g. if 20 Actives, 2 Pending => 10 months supply (Buyer’s market)

    2. (#Actives * #months) / #Solds in that number of months, e.g. if 200 sales in the last 6 month, with 50 listings today => (50 * 6)/200 = 1.5 months supply (Sellers Market)

  3. dkondo says:

    Dear E,

    Thank you for your response. Actually, my method of calculating months supply of inventory is the same as your 2nd method. I stated:

    MSI = #actives/absorp. rate

    Since absorption rate = #solds in that number of months/#months, then:

    MSI = #actives/(#solds/#months)

    Basic arithmetic tells us that if we divide something by a fraction (as shown above), we can multiply that by the inverse of fraction. Thus:

    MSI = (#actives * #months)/#solds

    This is the same formula you presented above.

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