Net Absorption & Market Health

What is Net Absorption in Commercial Real Estate

Net absorption means the same when considering any kind of real estate. It is not uniquely associated with commercial real estate (CRE). A very simplistic explanation of net absorption is the difference between the real estate that is vacant and the real estate that is occupied.

This calculation is done by taking into consideration only a single category of real estate at a time – either commercial or residential. Now, even if there are mixed-use properties, when calculating net absorption, the residential sections of the property are considered separately from the commercial sections. Net absorption is done considering the market conditions, location, and time remain the same.

Let’s illustrate this with an example and understand positive and negative net absorption –

TenantsInitial Occupancy (in sq. ft.)Changed Occupancy (in sq. ft.) CASE 1Changed Occupancy (in sq. ft.) CASE 2Company A200040002500Business B400025003000Entity C70014001000Gross Absorption670079006500

As mentioned above, the gross absorption in Case 1 has surged, making the net absorption positive, compared to the initial occupancy. The net absorption in Case 1 is 1200 sq. ft. (7900 sq. ft. – 6700 sq. ft.). In Case 2, however, the gross absorption is lesser than the initial occupancy, where the net absorption becomes negative 200 sq. ft.

Net Absorption plays an important role in commercial real estate investment because of the rigid lock-in periods and the long lease terms in the properties offered for tenants. If the net absorption of a particular area is negative and has been declining steadily, that is a cause for concern.

Net Absorption as a Market Health Indicator

Gross absorption for any given year and area can surge for many reasons. Not all those reasons can be considered a sustainable indicator of growth. However, an analysis of the changes in net absorption can give one an insight into the changes that caused the fluctuations in demand and supply. As an investor, that information is invaluable, since CRE investments are meant to be long-term.

Certain global phenomena, like the pandemic of 2020 caused a serious backlash to the economy of many nations. Needless to say, demand in the commercial real estate space also was affected. However, since the investment itself is of a resilient nature, CRE soon was back on its feet. Indian CRE market saw a surge of demand and supply even during the recovery period.

As an investor, when comparing net absorption, you should also bear in mind any kind of force majeure causes that might have upset the global economy. If that is not taken into consideration, you might lose out on profitable markets just due to omitted data and analysis.

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