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How to figure a home's fundamental value
: h; X+ b% M- G5 N) |6 xLeamer 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.+ j& q V5 M8 Z/ t1 Z0 I, ^# V
+ r5 S* p8 D' r2 B6 Q3 C9 B7 {( zNot 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 s$ `- g4 l- q/ ~9 [1 z
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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.2 K. d7 C2 h& `5 v4 g: S2 z
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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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In Boston, the residential real estate market’s P/E recently topped 30 -- compared with just under 20 in 1988.$ ]; C$ o- v* E* R0 o! l+ n
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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.- a* z7 U) C* ~: Z
San Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
: c3 ], F. E8 O. ]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.
o6 X y+ c* J+ f( 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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" c" ^1 x5 l( `% y& y! U4 `' W2 IIf 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.
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$ l6 K& m& ?7 y' R Home P/E ratios for 9 metro areas 6 |3 t, t2 i) I4 p2 [
Avg. 1988-2000 2001 2 r7 l, R! @, Q- i& z0 _
Boston 20.5 30.2 3 R* B, U5 ~; e2 } i
San Diego 22.8 29.7
+ R8 |6 s+ J8 k: G$ ISan Francisco 23.8 27.2 1 T8 Q7 A0 \0 F8 _+ e- a+ y2 Z
Los Angeles 21.3 25.6
& ^5 _# Q- N7 ]4 S m( ]8 u7 bSeattle 20.4 25
# o) r# O9 Y W) ]4 b2 ?Denver 17.7 23.7
1 w$ p0 U: U4 @: ?. i7 \: GNew York 21.2 22.5 R4 h% r7 k& D" T8 J/ f. F
Chicago 17.2 20.8 * Z* ?/ G7 Z6 g: O
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.+ P4 O% i$ v9 k. {* t! c* [
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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