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Nonetheless, even with all these caveats, the ratio of the median price of homes divided by the Shelter CPI displayed in the figure on the previous page is an extremely interesting number and has behaved very differently in LA and in San Francisco.
Keep in mind that these are only indexes that do not allow us to compare in any given year the p/e ratio in San Francisco with the p/e ratio in LA. They only show us how the p/e ratio moves over time in each community. I have accordingly adjusted the levels to make the two numbers conform in the early 1990s.
In the late 1980s, in both communities, this p/e ratio increased by almost 60%. The California recession of the early 1990s sent the LA p/e ratio back to its 1985 low value. The rise in the LA p/e ratio since 1996 has been much more steady than the rise in the late 1980s and we are still well below the 1989 peak. All good news for LA.
But the Bay area is very different. Like the US stock market, the p/e ratio for San Francisco homes is at an all-time high. The decline after 1989 was much more modest in the North than the Southland, and it was back to its peak value by 1998, and from 1998 to 2000, the North p/e ratio simply skyrocketed. A brief decline in the median price of homes in 2001 lowered the p/e ratio but the market is off and running again in 2002 which has returned the p/e ratio virtually to its historic high.
What are they smoking up there?
Increases in rents may justify a high p/e ratio for housing, but maybe not
Some of the difference in p/e valuations in the North and the South may be due to differences in the rates of growth of "earnings". The chart below displays the CPI of shelter divided by the US GDP deflator. The erratic behavior of this series prior to 1983 reflects the error made by the BEA - they used asset prices to measure the cost of shelter. Since 1983 we have rent values only and a much smoother picture. We see here that San Francisco and LA have shelter costs that move virtually in lock step until 1994 when San Francisco became considerably more expensive.
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* Edward E. Leamer,
Director, UCLA Anderson Forecast.
Check the link for author's profile: http://www.anderson.ucla.edu/faculty/edward.leamer/pdf_files/cv.pdf
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