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How to figure a home's fundamental value
. y$ Z, i8 l$ \0 y! [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.2 w) u7 A- ]( Q) z$ r2 Q
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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.# O' S \4 w3 F6 o8 R5 ?# O" F8 k
1 S: j) ^$ B+ K' q8 ^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.1 o9 i; W# O6 i4 \" V4 `
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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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; u# c6 R$ z( ZSan Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.* O% k1 P' N3 K; U7 [" t: m
San Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.
$ D/ X) {% u- J; B b) G* `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 1988.2 G5 F- A$ C+ Y# M a2 i8 I0 t" U
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. 6 t# e6 l0 [) _' g D
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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.8 N* [' F: G2 w' u7 o# |
9 D- w2 t7 a9 T/ n) C! y9 bIf 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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- _. u9 F% Z" f9 U6 A* B# w# M. P Home P/E ratios for 9 metro areas
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5 W+ J) E9 s4 ^/ {8 `* M( R' LBoston 20.5 30.2
$ M+ A# ^" M: ^San Diego 22.8 29.7
q7 _1 u0 E5 d( L0 y- ~San Francisco 23.8 27.2 & X% Q& s& n9 }
Los Angeles 21.3 25.6
! K+ B5 H( z: H! v1 h4 `( rSeattle 20.4 25
; g( j% @4 z' kDenver 17.7 23.7
3 y; b& T, N- H Z9 v/ k# `New York 21.2 22.5
" u3 l4 `! B6 e; G& F$ uChicago 17.2 20.8
' f' C0 l$ U: T, a7 Y5 FWashington, D.C. 17.1 20.4
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: K0 r7 _& u# ]) Z) nIt'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.& w& z9 s/ Q ~5 m
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From: http://moneycentral.msn.com/cont ... ingguide/P37631.asp |
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