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How to figure a home's fundamental value
+ n9 P8 y* B3 Y. ?+ z: h* K, p2 @. _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.
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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.
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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.) h8 Q6 r! t8 D9 P9 P6 H) \
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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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. H& f9 [. M* O3 fIn Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988.7 ?5 r I8 \6 q! Z! G7 i
7 c, o: f5 O* O) [& sSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.
1 Z; g. @6 e) F% [0 dSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
: G7 V/ N6 @$ ] @! X: C Y8 ?4 p d7 SNew 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.
4 \6 V! V+ R8 ~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.
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! v, r3 \! l( x4 y3 c# bIf 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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& q- Q8 H" d: e' F9 qIf 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
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1 @, e3 [+ I; H4 D4 B8 g4 }) k0 MBoston 20.5 30.2 2 s2 {. W4 S7 q5 ?) V, g3 N: W
San Diego 22.8 29.7 $ k3 ^/ J# S& ~3 U8 e
San Francisco 23.8 27.2
I. I+ ]. t% K6 R' jLos Angeles 21.3 25.6 8 `4 h) t- n, Q9 F& V1 L3 _9 n* D& v
Seattle 20.4 25
' }! V1 i, L$ y) FDenver 17.7 23.7
! j, X, t# j0 S. W2 g' b+ U: f" f( Y, tNew York 21.2 22.5
, E& W+ i/ W- P. c' h& NChicago 17.2 20.8
4 b! T5 ?- x# |Washington, D.C. 17.1 20.4 + x6 K" ]5 m; @, i# S$ J9 Z! T, E
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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.$ r: F7 I- ^4 k6 Q3 P+ v5 p9 k
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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