The Importance of Accurate Calculation of Absorption (Gross and Net)

Understanding inventory demand in different real estate markets and sectors has always been a relevant topic. Anyone who prides themselves on being a serious investor in the real estate sector has not only the duty but the responsibility to have firsthand knowledge of this and other fundamentals, using the best and most transparent methodology in the industry. Relying on supply and demand data without an evident methodology for, for example, underwriting an investment project would be, as we say in Mexico, "shooting oneself in the foot."

In the document "Improving Market Analysis in Commercial Real Estate" by the Appraisal Institute, the calculation of gross and net absorption is explained as follows:

• Gross Absorption: Square meters occupied during a specific period of time.
• Net Absorption: The difference between occupied and vacant square meters.

In line with one of the most reliable sources for commercial property valuation analysis in the United States, SiiLA has been calculating these metrics in the same way for the past six years in Brazil, Mexico, and Colombia. Gross absorption only considers the square meters occupied, exclusively for operating buildings (1) within a specified timeframe. Net absorption, on the other hand, represents the difference between occupied and vacant square meters in a particular market, without considering the square meters of new inventory in the same period. This is because new inventory in a specific quarter constitutes new supply, not necessarily a metric related to occupancy or vacancy (demand).

Having a correct and transparent calculation of these metrics, particularly net absorption, is crucial, especially during a pivotal moment like the one we are currently experiencing. This is particularly relevant in the office asset class, which is currently a tenant market, with closing prices under pressure, changes in contractual terms, space reduction, and shifts to alternative business models, among other factors. Not having knowledge about the factors to consider in such a simple equation can have serious repercussions on financial projection models. It can impact the structure and cost of capital, the interest rate of a specific loan, the holding period of a project or property, future cash flows, discount rates, marketing periods, asset availability, and more.

The impact is not limited to investment activities alone but also affects tenant representation and landlord representation services. An improperly executed analysis of absorptions could lead to unfavorable negotiations when leasing a space or renegotiating contractual terms. Similarly, valuation analyses of institutional properties rely on metrics such as gross absorption velocity and its intersection with tenant exits. It can be concluded that if constant monitoring of 100% of the tenants in a particular market classification is not in place, tracking net absorption is practically inconceivable.

At SiiLA, as providers of data and information, we take responsibility for transparently showcasing the correct process of data collection, analysis, modeling, and adopting the best methodology to serve our users. We ensure that we adopt the best methodology to put it at the service of our users.

Therefore, one of our objectives is to create and present more transparent processes with methodology in the real estate sector.

Note1: All pre-leasing is considered as gross absorption once the rentable area enters the market as new inventory.

Source: "Improving Market Analysis in Commercial Real Estate Appraisal Assignments" by David W. Koepe. Winter 2019.