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How to figure a home's fundamental value7 r4 A; h" o5 s- N1 S2 O) h
Leamer says he can tell because homes, just like stocks, have a price-to-earnings ratio (P/E) that he believes determines their fundamental value. The “earnings” part of the ratio consists of the annual rent the house could command. Homebuyers can compare current P/Es with historical levels, Leamer says, to get some idea of whether houses in their cities are becoming overvalued.2 z0 |7 U& n, E: W. D- d2 o
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Not everyone buys the idea that P/Es dictate value. But investors who completely ignore P/Es do so at their peril, as many have learned in recent years. Leamer, who heads the prestigious Anderson Forecast at the University of California in Los Angeles, points out that the P/E for the Standard & Poor’s 500, a key stock benchmark, was nearly double its previous historical high when the stock market bubble burst in 2000. When home P/Es peaked in California, Boston, Dallas and other markets in the mid-1980s, devastating real estate recessions followed.1 I, o& K- m& L, f( j1 l" s
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Leamer didn’t invent the concept of P/Es for homes. But his willingness to proclaim bubbles in several of the nation’s hottest markets has brought him lots of attention recently.- E8 A# R9 n! M9 P( [, P+ p
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To calculate P/Es for entire cities, Leamer divided the median home price in each by the annual rent for a two-bedroom unit in each city -- and looked at P/Es each year since 1988. Here’s what he found:
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3 F. V# b' h) ?7 T" I, X0 u: {In Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988.
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1 O8 P( R+ m. l! v2 q8 l' PSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.
' T: b3 Q! G6 Y% YSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
6 ?8 F% y. G: k% e4 l0 G. WNew York, by contrast, is actually well below previous peaks. The area’s current 22.5 P/E is above its recent nadir of 17.6 in 1993, but down from 28.6 in 1988.7 M$ v2 ^' c0 U" }) S
You don’t have to know exact P/Es, however, to spot signs of trouble, Leamer says. Any time there’s a disconnect between prices and the underlying value of homes, as measured by their market rents, there’s the potential for a bubble. ; i9 X& D0 l" L, U
$ K8 ]0 H& q4 @$ LIf home prices are rising much faster than rents, as is true in Los Angeles, that’s a strong indication a bubble is forming.
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If home prices are rising while average rents are falling -- which is the situation in San Francisco -- the bubble is pretty much unmistakable.
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Home P/E ratios for 9 metro areas 4 \, Y! u4 K4 k% G+ K
Avg. 1988-2000 2001 # B# w1 C. Y8 }, s% m. A
Boston 20.5 30.2 7 o1 z( K; r1 `4 `
San Diego 22.8 29.7
8 s W) J. Y3 v( n+ z' Q2 o# D0 P2 V" mSan Francisco 23.8 27.2
4 ^# h' ?9 c% G. RLos Angeles 21.3 25.6 Z: @$ p7 z: B0 D. j
Seattle 20.4 25 2 k7 D) w' }6 _- N
Denver 17.7 23.7 # `2 C5 w4 t. c4 \9 A
New York 21.2 22.5
! e3 B+ W8 j ?1 cChicago 17.2 20.8
& ]. C& D# P5 w6 m6 \5 K7 HWashington, D.C. 17.1 20.4 ! u/ W& r' U4 Z* T6 ~1 z
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" P; m6 d; {7 R' h4 T$ _ mIt's difficult to compare P/Es from one city with those from another. P/Es in Atlantic City, N.J., have wavered between 17.3 and 11.6 since 1988; in San Diego, P/Es have not dropped below 20. But you can look on the P/E as a measure of risk -- that is, the higher the P/E is above its average level, the greater the risk, no matter where you live., \! q1 N( N" Y6 A
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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