In value adding transactions, there is often a need to make significant renovations or lease a significant amount of vacant space.
And in order to estimate how long it will take to lease a space, the key metric to understand is the absorption rate.
The absorption rate is a measure of how quickly space is “absorbed” into the market. There are two types of absorption: gross and net.
Today, I will try to explain the gross absorption rate.
Net Absorption Vs. Gross Absorption
Gross absorption measures total square feet absorbed or leased in the same period, without regard for vacated spaces.
While gross absorption measures total square feet (absorbed and/or leased) but without the vacated spaces, net absorption accounts for that space as well.
The rates are typically expressed by specific property types and asset classes.
Net absorption is the difference between tenants physically occupying their space and tenants vacating space.
For example…
If we have a 100k sf office (with some vacant space) building and a tenant vacates 50k sf, but then a new tenant comes along and physically absorbs 75k sf during the same time period, then you would have a positive 25k sf of NET absorption.
Available space = 25k
Vacant Space = 0K
On the other hand, if that same 25k space is available AND vacant, but a tenant comes along and leases it, but doesn’t move in for another 5 months – that space is no longer available and vacant. It is just vacant and it looks like this:
Available SF = 0 SF
Vacant SF = 25,000 SF
Gross Absorption Example
If the total amount of some suburban retail space is 1,000,000 square feet, 50,000 square feet is leased and 20,000 square feet are vacated during the year. The annual gross absorption rate, in this case, would be 5.0%: 50,000sf leased divided by 1,000,000sf of total space.
Gross absorption = Total amount of space that tenants (in a specific geographic area) physically occupy during a specific period.
The formula for calculating gross absorption is: Existing Inventory + New Construction – Space Removed from Market.
Different Sources May Measure Gross Absorption Differently
You have to check with your CRE source before operating any numbers, especially sealing with net and gross absorption.
Some sources may not include sublets, leaves renewals, or spaces that are still under development.
At the end of the day, gross absorption rates only tell you the amount of leased space. It can be helpful for seeing areas that were absorbed more than others.
How Can Gross Absorption Be Used
Gross absorption isn’t a measure of net growth or trend. For that, you’ll need net absorption.
Although gross absorption could provide useful information about growth, it’s still only a part of the picture. It shouldn’t be used in isolation or without a full understanding of what gross absorption means.
Why The Absorption Rate Matters
The Gross absorption rate is a critical input into a pro forma projection of cash flows and/or a property’s business plan.
Gross income funds will provide the capital needed to pay the property’s operating expense and the debt service on the permanent loan.
Gross absorption accounts for any leasing activity that occurs in an asset of the selected market.
Any time a lease is signed and space is occupied, it counts as an addition to the gross absorption rates and metrics.
For example, if a tenant who occupies 10,000 square feet of space moves from one building to a different one, there has been 10,000 square feet of gross absorption in that market.
2021 Commercial Office Gross Absorption Picking Up
Overall, gross absorption in San Francisco was 2.9 million square feet, a 184.5% improvement from the second quarter of 2020.
The report includes office, industrial and retail assets in its analysis. The retail sector drove much of the gains in the second quarter.
Overall, the San Francisco peninsula has a 7.7% vacancy rate, a 150 point increase last year from the same time last year.
IPG forecasts the vacancy rate will continue to increase, as will rental rates. Gross absorption and net absorption in the construction pipeline are also expected to increase this year.
All good signs of the marker stepping toward recovery from the pandemic.
