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How to figure a home's fundamental value
3 r+ @; U" k# c$ ^+ h- lLeamer 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.. F) m0 h" t' W, C; ~' b$ ^7 w
/ K8 W/ g& H+ s' r0 M( d# L& pNot 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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5 ]) l% U) S: J9 C4 s# G4 FLeamer 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.; G: {+ l7 l. k R: W9 R6 T q
9 c7 _0 L4 `& W# v! Y& e. jTo 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:/ @) ~0 z0 z3 s3 x
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% e* y- Q9 S0 y; O K- vIn 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.
# z$ Q4 e2 z/ K" A/ y; a! T; fSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.0 d3 |( I" \" _; J
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.
5 D4 H; T" D+ v5 |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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5 ?3 [" _. T9 T) \$ K; yIf 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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0 v( ^/ o9 x [5 F0 N) P+ i. @If home prices are rising while average rents are falling -- which is the situation in San Francisco -- the bubble is pretty much unmistakable.; z9 [5 F) b' M3 h8 d1 k4 o
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Home P/E ratios for 9 metro areas ' {( a% T, R- O/ Q
Avg. 1988-2000 2001 - u# q0 r0 f3 p
Boston 20.5 30.2
) m( w, V- A0 e7 TSan Diego 22.8 29.7 0 [. i3 U. V3 ^1 G* c
San Francisco 23.8 27.2
9 d# c- l! A" `, E, I4 Y* W8 lLos Angeles 21.3 25.6 - _. C) M9 G& l! R2 E' q
Seattle 20.4 25 ( C. R- S: j8 y* k9 O/ Z
Denver 17.7 23.7
( ]; l6 t% g' V' s9 w4 ENew York 21.2 22.5 - _7 R. k7 e% b# e4 H7 g/ M
Chicago 17.2 20.8
+ S) F! e: P Y! X* z$ v) XWashington, 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.) c1 ^' h: g9 a/ ]3 Z4 y4 p* q
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9 ]0 ]+ d( o' A. ]From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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