This week's Fortune magzine featured an interesting article that puts an interesting spin on the housing market that takes a page from the real estate investor's playbook. 

Followers of the equities market will be familiar with the P/E ratio, the most often quoted financial ratio calculates a company's share price as a multiple of its earnings.  A high P/E ratio is evidence of the market's collective assessment that earnings are poised to grow dramatically, whereas a low P/E ratio tend to stick to companies with poor growth potential. Sky-high P/E ratios are not sustainable.  Either the companies blow up (pick the dot.com of your choice as an example) or they mature, stabilize, and earnings "grow into" the stock price (Ebay, Microsoft, etc.)

So what's the P/E ratio for the property market?  It's the relationship between property values and rents. 

Again, for investors, this is pretty intuitive.  How much do you want for that starter house?  $500 thousand you say?  And it should rent out for $2,000 per month?  Hmmm....I don't even have to plug that one into my economic model to figure out that those numbers don't work.  The only way that investment will pan out is if the market races along for another couple of years at double digit rates of appreciation.  If that's your belief and you're willing to put your money where you mouth is then by all means go ahead and write that earnest money check. 

But, like P/E ratios in the stock market, sky high price-to-rent ratios are not sustainable (which is why, for the time being, Jeff Brown is sending his sunny San Diego investors hunting for deals in the Great State of Texas).  The article quotes Yale economist Robert Shiller: "Like P/Es, price-to-rent ratios are mean-reverting."

There is a little bit of good news hidden in this analysis, however.  Once the price-to-rent ratio gets out a whack there are two ways for it to drift back in line: a) property prices fall or b) rent rates go up. 

Fortune crunches the numbers for the major metropolitan areas and they stack up pretty much how you'd expect them to.  The article isn't online so you'll have to hit the newsstand and plop your $4.99 down if you want the details.