Net absorption is the change in leased space in a specified commercial market or locality, between the current time period and the last specified period. Net absorption is basically the difference between the commercial spaces vacated in a certain time period by companies or tenants and the spaces taken up by them or other commercial entities in the same locality of commercial place.
Net absorption is a very important metric, to look at supply and demand dynamics in a commercial market. Gross absorption only looks at one side of the picture, that is, total space taken up or occupied in a particular market in a specified duration.
Importance of net absorption
Net absorption is a clear cut indicator of the space that is in demand in a particular realty market. Investors, developers and brokers depend on net absorption for their real estate activities. A high positive net absorption means that there is a good demand for commercial space. This means the real estate market is growing in a healthy manner. On the other hand, negative net absorption states that the demand for commercial real estate is going low.
Calculation of Net absorption example
The total amount of space vacated during a particular time from the total space leased in the same market during that time is equal to net absorption.
Suppose three tenants – A, B and C – have rented space in Delhi’s CBD Connaught Place. They occupy 100 sqft, 150 sqft and 200 sqft of space, respectively. So the total area commercial space occupied by them in Connaught Place is 450 sqft.
Now suppose, A and B move out of their current places and occupy new spaces in Connaught Place while C continues in his existing premises. ‘A’ moves to a 200 sqft premises and ‘B’ moves to a 250 sqft place.
So, the total space vacated in Connaught Place will be 250 sqft (100 sqft +150 sqft).
The total absorption in Connaught Place will be 450 sqft (200 sqft +250 sqft).
The net absorption will be 450 sqft – 250 sqft = 200 sqft. The net absorption in this example is positive.
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What is negative net absorption and positive net absorption?
Positive Net Absorption means more space was leased than what was vacated/supplied in the market. It basically means that there is decrease in supply of commercial space in a particular market. Commercial rents in a positive Net Absorption scenario would tend to rise. Negative Net Absorption means that more commercial space was vacated/supplied in a particular market than what was leased or absorbed by commercial tenants. Under negative Net Absorption scenario, the commercial rents would tend to fall or cool down.
Net absorption is of special interest to real estate companies and also for brokers, investors and commercial tenants to look at risks, opportunities and get a better picture of the overall market dynamics. An investor looking to park funds in commercial real estate should avoid a particular market if there is a trend of negative net absorption in the market under consideration.
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What are the factors that impact net absorption?
Pandemic
A pandemic like the covid-19 impact net absorption rate.
Over supply
An over supply of projects will lead to negative net absorption with tenants leasing new places. In fact, tenant movement can cause both positive or negative net absorption.
Terms of the lease
The duration of the lease can impact the net absorption of a property or a specific market.
Economic conditions
Economic growth and job creation can drive demand for space and positively impact net absorption.
FAQs
What is a good absorption rate?
Absorption rate that is positive and is above 2-3% is a good absorption rate.
What is a negative absorption rate?
This is one where the supply is more than the demand. So while there is a lot of space that is available for lease, very less has been rented. This stands for weak real estate performance.
What does low net absorption rate indicate?
Low net absorption rate indicates that the space has not been rented out as it was envisaged to be.
What impact the net absorption?
Factors such as construction activity, economic impact etc. impact net absorption.
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