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How to figure a home's fundamental value
9 }' A' F$ o- I! M+ u% a" j( BLeamer 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.
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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.7 `$ {; ?, g: 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.
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% a5 p5 `) {+ b% ^- p, }+ m$ JTo 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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In Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988.
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% v, x8 O5 o3 `& k8 L, n2 zSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.
2 @* J' q0 l, DSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
. u2 T: ^ E1 N0 k+ nNew 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.
9 |( a2 D( ~- ^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. ( M0 f% _, ]* N9 t- [9 ~% q
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If home prices are rising much faster than rents, as is true in Los Angeles, that’s a strong indication a bubble is forming.9 d& v+ W( y8 {" i
# _7 j( j4 r% h, n o0 wIf 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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1 B" x( z& U5 h _6 c0 t Home P/E ratios for 9 metro areas 0 u' F# s' @, h* A
Avg. 1988-2000 2001 D/ B, F, |' _, `/ S+ B6 W
Boston 20.5 30.2 + W7 K6 N7 L5 F4 |+ i5 A6 J
San Diego 22.8 29.7 ; J$ Q& O, C$ t; X* h* {2 `& \
San Francisco 23.8 27.2 ; G$ y$ x- n2 N; B/ G+ Z0 n8 H
Los Angeles 21.3 25.6 / k! h# j! ^* @0 c# D+ s3 f
Seattle 20.4 25
: l) r& m& t/ ~0 iDenver 17.7 23.7 6 v6 }, A o! H5 h) \
New York 21.2 22.5 9 A! z- J8 q% y- f e* @. m5 _
Chicago 17.2 20.8
% r4 B- ?/ ]& W# U2 z+ j1 `5 BWashington, D.C. 17.1 20.4 ; ~7 s* ^* I) F) \ K
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It'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.
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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