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How to figure a home's fundamental value* ^1 q- ?( K% J3 D! h0 |
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. ]" T* q; L8 F/ N+ \* S* @, m1 v+ P
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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.0 I$ g0 Y" S/ T2 \; W* h3 g% a
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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.
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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.
3 N# M2 R$ N1 P% q0 ]" u, oSan Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
: f! r6 b2 B0 d2 r& w8 yNew 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.
]7 N9 F" e6 X, j! S2 jYou 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. ( B, O8 C9 c% Z) w! \3 [+ p
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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.
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. S" z: G1 _- h5 u: q4 a0 E: \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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; ~: `' a( F+ z6 m0 v1 s5 | Home P/E ratios for 9 metro areas
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! \: }2 _+ {" G" e- D" \Boston 20.5 30.2
# h5 I5 A+ q( e3 H5 PSan Diego 22.8 29.7
$ @: ]5 s6 R$ \6 c. R8 ~; s# PSan Francisco 23.8 27.2
# ]- d$ f0 q/ b J/ jLos Angeles 21.3 25.6 . I+ V$ I/ J& C) x0 G* e( t
Seattle 20.4 25
* z' N7 ?7 Q* s3 Y. b- z, M* G$ ?1 YDenver 17.7 23.7
$ D3 B# e6 N, h! _8 dNew York 21.2 22.5
3 t( ^3 O2 s- B1 U, l9 EChicago 17.2 20.8
/ }# Z; t1 v6 w, e3 B/ TWashington, 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.
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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