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How to figure a home's fundamental value
, o5 P) J% K, w, `4 u cLeamer 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." M F8 ^& J [0 o
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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.7 ^: g; e7 {3 G/ w: O" ]% d6 l
" @. F: ~, ^4 c. ^, Y5 Q3 E5 ]$ S: PTo 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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San Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.' Y* k' C" G# V' o' E4 H" K+ D$ o
San Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
& q! W0 n. c4 a! u/ R9 ONew 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.
& d( L9 p/ h; P1 |) i6 r- _, VYou 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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, ~5 c( {" M4 j- M) |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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4 ]' S. r. k/ F) V. pIf home prices are rising while average rents are falling -- which is the situation in San Francisco -- the bubble is pretty much unmistakable.5 t" l7 I% G/ s$ }7 U! I/ J2 ^
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Home P/E ratios for 9 metro areas
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Boston 20.5 30.2 - l @9 q3 l' Q3 d4 c1 I# U6 T
San Diego 22.8 29.7 " F) f. `' u/ K# r$ N! l( Q# k- @
San Francisco 23.8 27.2 * n2 D0 q6 F- x5 E- b9 h: Q/ j
Los Angeles 21.3 25.6
) Z, x, i& L M( @1 USeattle 20.4 25 0 S# k9 X* W3 B5 c
Denver 17.7 23.7
+ w2 {1 ?7 X, L0 h# NNew York 21.2 22.5 ( A8 l6 D- I3 d+ |
Chicago 17.2 20.8
) e. C, o x0 S8 W. E8 ]4 wWashington, 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.) E" m4 S- {. z0 V% v8 c
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* I N' V! g) U+ A9 x/ YFrom: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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