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How to figure a home's fundamental value' e7 [2 ?) H8 d& h6 v, V6 z9 v
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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" u; J, z( G& X+ ~2 y/ hLeamer 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 b% _, b q4 G1 l. i, f
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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.
; E$ c, {0 u) s% vSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
8 c5 J; \* A+ M! ~8 u8 L; f# wNew 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. K! Z! S4 P# r- P8 f" \
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. . i8 L% G! u$ E+ G2 `' x( B0 t- L: N9 c
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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.0 N, t5 n! F* k
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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.0 m4 Y* l+ }# l4 m% [9 w: O
. Y6 M2 B% ^. O Home P/E ratios for 9 metro areas ' r9 S( P; D. m+ S4 b4 [, K
Avg. 1988-2000 2001
' _ C" C' o6 L" l XBoston 20.5 30.2
; ]! i3 ]4 N+ C- DSan Diego 22.8 29.7 * U9 @& |, _, D' {
San Francisco 23.8 27.2
# K6 \2 S3 f g/ E# KLos Angeles 21.3 25.6
( r# O7 @/ J0 [4 D( XSeattle 20.4 25 9 v2 F$ D, V7 m" Q c z
Denver 17.7 23.7
/ I% @! o, j3 s+ G7 m3 \. O) CNew York 21.2 22.5
& ~4 u( C6 e4 T! U0 I% \. }0 ~! qChicago 17.2 20.8
: }" Y2 O6 x0 n; N' {$ }Washington, D.C. 17.1 20.4 9 t0 `6 n! ]2 `3 q# Y
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7 U' r+ L) `. t0 xIt'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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1 Q1 p! H0 G* LFrom: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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