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How to figure a home's fundamental value
) w8 X+ B' j3 r1 q$ ZLeamer 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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0 ?* B1 \. O7 {, w1 s7 _( Z2 ?3 VLeamer 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.% n! u! q$ C3 }3 ?1 h) P
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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 1988.1 E% K+ M, P! ^. z
S; ~) G( A2 _1 G" } A4 |4 {$ WSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.
+ T: M* y- \1 b" WSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.3 ~% m9 O6 e5 T8 Q
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.
. S+ i( F8 z4 l# T' L. ~* uYou 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. 8 H& ~- x W" z4 q
% `. h- A, \7 X! X: i- V: RIf 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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" e. s' B' i7 N! O5 e# ^% L6 VIf 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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Home P/E ratios for 9 metro areas " A" ?) ]' r# x2 v$ h
Avg. 1988-2000 2001
9 j6 R, C, K) D: U% L; tBoston 20.5 30.2
# ?5 d6 E) o1 J7 |; h, ^- {$ _San Diego 22.8 29.7
- l3 K. O0 S. i: y+ qSan Francisco 23.8 27.2 ( C! t. _3 f8 ]1 F
Los Angeles 21.3 25.6
4 e6 l |9 l; T, HSeattle 20.4 25 * H0 L3 i- P- T7 `3 |
Denver 17.7 23.7
$ l3 X- h+ `4 V/ F- Q; N0 N( v7 i& eNew York 21.2 22.5 6 n) E7 y& c& S& D! n$ y/ o* @% \
Chicago 17.2 20.8
( w# w9 | n" {- c8 N& n3 z5 ?Washington, D.C. 17.1 20.4 5 O: ~) T1 K+ Q- U( v! c
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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.& x `4 m: o+ A: w q
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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