Understanding a Real Estate Market - Key Terms & Metrics

To be successful in real estate, you need to intimately know your market. When you know your market, you will know the local players, the leasing/sales history of properties, strengths of the local economy, and the brokers and owners. All of this allows you invest in real estate a its true value and not at the "out of town" price.

The key metrics you need to know are:

• Inventory
• Vacancy
• Absorption
• Market rent
• Market cap rate

Inventory

Inventory is the amount of square feet a market has of a particular asset type. For example, if there are 100 office buildings in a market and each is 100,000 SF, then the total office inventory for the market would be 10,000,000 square feet. This number is important when looking at the asset allocation or concentration of a market. If the the north part of a city only has 1 million square feet of office inventory and the south has 20 million square feet, most likely you would not want to buy an office property in the north.

Vacancy

Vacancy is expressed as both a gross value (usually called "availability") and as a percent ("vacancy rate"). High vacancy is bad. When there is a high vacancy rate, it usually indicates either a fledgling economy or overbuilt market. The biggest reason vacancy is bad is for releasing. If you are buying a 60% occupied value-add property, you don't want to compete with all the other vacant space in the market. It is important to look at vacancy rates over the past 5 years. Some areas might have a higher vacancy rate but are going through a rebirth.

Absorption

Absorption is expressed in terms of absolute square feet. It is the amount of square feet that was leased up less the amount that came onto the market during a particular time (i.e. became vacant). When absorption is positive, vacancy is dropping. When it is negative, vacancy is increasing. When there is a large amount of positive absorption in a market, it signals that leasing activity is strong. This is one way to gain assurance that if your building goes vacant, you will be able to lease it back up with minimal down time.

Market Rent

Market rent is a very general rental rate for an asset class and quality. If a report says that the Class A office market rent is $20.00/SF, that means in general, that is what your rental rates should be at your Class A office building. This number can vary greatly based on the quality of the building, quality of the tenant, location, etc. Also, be sure to look at market rent on a historical basis. Rising rental rates indicate a strong leasing market.

Market Cap Rate

A strong real estate market will have a history of increasingly dropping cap rates. As with all the other measures, be sure to look at the cap rate trends over the past 5-10 years. The cap rate is a good sanity check to see how your potential investment's cap rate compares to the overall market's. However, remember that this is only a sanity check. Cap rate is affected by many factors.

Check out our Real Estate Career Guide for even more information on how to analyze a real estate market!