Is Your Home Price at a Justifiable Level?
Profit Ability Article Highlight

Anyone who has dabbled in the stock market knows about the Price/Earnings (P/E) ratio of a stock. This fundamental metric is used to help gauge the value of the stock. In many cases, a stock with a high P/E ratio is considered to have great growth potential. If the company can't produce the expected growth, the market will often devalue the stock, thereby resulting in a lower P/E ratio. In the same way stock market investors use P/E ratios to determine a stock's true value, a similar technique is being used by some real estate analysts to judge a home's value. Analysts are taking a P/E ratio approach to real estate prices to determine if stratospheric levels are justifiable.

Simply put, in determining the P/E ratio of your home, the "P" would equate to the home's current market value, and the "E" would be what you could earn by renting the property. Even if you don't ever plan on renting, a key premise to using a P/E ratio for home prices is that you might someday consider renting your home if it became considerably cheaper to do so; others might avoid purchasing homes and choose to rent instead if the market conditions favored renting. We must examine a home's P/E ratio over time, compared to other homes' P/Es in that same area. It is important to compare the P/E ratio for homes within a given area, because a high P/E isn't necessarily a bad thing if the area can sustain the high demand for housing with new jobs, continued economic growth and low interest rates.

The good news for those who have a high home P/E is that, according to experts, real estate "bubbles" aren't prone to burst like a stock bubble might. The relatively stable housing market would more likely deflate slowly as the buyer pool dried up and prices equalized. Most homeowners would more likely hang onto the property rather than sell at a loss. The upper section of the chart to the right lays out numbers for various metros across the country. These numbers are based on changes since 1993. Boston, Miami and San Diego top the list for P/E ratios. For our Orange County readers, we have selected a set of OC cities that represent a crosssection of the local market. This set of numbers is based on data from 1996 to present. As you can see, many Orange County cities have home P/E ratios as high as any in the country. Simply put, OC home prices are pacing ahead of their respective rental rates to a greater degree than many other places in the country. North Orange County's Yorba Linda holds the highest home P/E ratio at a whopping 52%. Also holding relatively high P/E ratios are Tustin, Costa Mesa, Newport Beach and Orange.

Calculating your home's P/E is quite simple. To calculate, use the formula to the right. Please keep in mind that the "Home P/E ratio" measure is just one way, and a theoretical one at that, to measure the true value of a home. It is important to conduct your own research and consult an expert in the field before taking actions in this area of your finances.

If you have any questions on your home P/E ratio, you can contact us at info@talleynco.com.