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How to figure a home's fundamental value
7 b- j: B; u, g! r; yLeamer 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." n8 o, A8 [ d3 b* |& r5 r3 V
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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.( [. y1 j, R7 T
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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:9 {% y7 j1 v6 X- l* R x
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In Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988., g2 r8 U. I! O: B1 g
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San Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.3 `9 P5 j! d g8 l
San Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.) Z9 W9 M; h$ n6 s; ]: H
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.
8 Q C) H5 ?. AYou 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: ^+ V! F6 m5 t/ ~3 r9 S1 @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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. U& a3 `% G8 `& \ b9 ^( y+ Z }If home prices are rising while average rents are falling -- which is the situation in San Francisco -- the bubble is pretty much unmistakable.9 |6 S2 P0 g6 C5 z6 X( z$ }
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Home P/E ratios for 9 metro areas
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Boston 20.5 30.2 & z( n2 C) s% e' t/ S
San Diego 22.8 29.7
# Z: M0 \9 b. i- @0 N' h+ B5 _San Francisco 23.8 27.2 - t+ a" n1 B! s1 f5 ^) u3 s
Los Angeles 21.3 25.6
" E$ e" z% @* s- t# _Seattle 20.4 25
; w4 P* m4 S/ Y5 QDenver 17.7 23.7 4 n5 F( x; s( J) t# @
New York 21.2 22.5 ; d- o g7 a2 w
Chicago 17.2 20.8 - G5 D4 m' D$ b% w
Washington, D.C. 17.1 20.4
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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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, }5 w; W. f) w( m, t7 m- @0 J) L/ dFrom: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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