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How to figure a home's fundamental value! R% Q+ Q6 w) c& d, h, X I
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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. D/ e7 `6 n1 }( O7 p4 {. t# I) nNot 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 V! u4 c7 t& U; y; f
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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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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:4 |/ Z! E9 u: L9 e, K' w
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In Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988., E" s9 i8 Q$ T6 ^# `
" M9 E/ ?& J3 r' ZSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.
- w: U; C' W O" E" ^" z4 E# hSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.$ R2 h0 I3 p# R& k) {+ j2 E' r
New 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.: y$ E/ X6 B8 u9 f% D5 K
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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If 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.( f. @, K! g j% y1 F- n
+ F+ R |. j& ~ Home P/E ratios for 9 metro areas 2 Q5 A$ o7 J6 J4 @1 P ^! g2 V/ a8 L4 L
Avg. 1988-2000 2001
* }$ y* l, J9 u) ], wBoston 20.5 30.2 + t* ?3 c) h- l1 f! o7 L
San Diego 22.8 29.7
0 H! |- f4 l4 w0 t, n$ k1 bSan Francisco 23.8 27.2 + F, o4 S$ D0 b( }, j1 A
Los Angeles 21.3 25.6 8 {% `6 z5 N. L9 }8 Z
Seattle 20.4 25 8 A! M) ] x4 D @" x; {( p- |
Denver 17.7 23.7
' ]/ Q3 R' g4 g+ j( k3 dNew York 21.2 22.5
( h/ r: n8 H. k# q3 u2 l, ?Chicago 17.2 20.8
" m, g8 P6 J7 ?5 TWashington, D.C. 17.1 20.4 / h9 o }/ Z$ S
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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.$ I. u O! H! h( p0 I+ M( p
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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