Jeremey Grantham: “A Storm Is Brewing” in the Global Real Estate Market

Jeremy Grantham is a billionaire investor and one of the most closely followed voices on all of Wall Street. He is the co-founder and Chief Investment Strategist of GMO, an investment firm with well over 100 billion dollars in assets. Grantham has never been afraid to speak his mind when it comes to calling a bubble, having successfully called the tech bubble of the early 2000s and the Great Financial Crisis in ‘07 and ‘08. Now, Grantham is warning that these prior bubbles pale in comparison to what’s happening currently in real estate markets across the world. Here’s what he had to say.

One simple way to gauge home affordability is to compare the annual income of a typical household, with that of the average price of a home. Let’s use Jack and Jill here as an example. Let’s say that Jack and Jill combined make 60,000 dollars a year. That also just happens to be the median household income in the city that they live in. At the same time, the average house in the area costs 240,000 dollars. That means in this example, the average home costs 4 times the median household income. Calculated by simply taking the average home price and dividing it by the median household income. Think of this metric as similar to a PE ratio for a stock. The higher the PE ratio, the greater likelihood that the stock is overvalued. All else being equal. The same basic logic applies when comparing the median household income to that of the average house in the area. The higher the ratio, the more likely the housing market is overvalued.

Let’s say a few years pass and Jack and Jill’s income rises from 60,000 a year to 70,000 due to inflation and wages increasing in their city. This 70,000 number is also the median household income now. However, during the same time period, the price of the average house in the area skyrocketed from 240,000, all the way to 420,000 dollars. During the same math as earlier, we can now see that the average house in this city is now 6 times that of the median household income. The reason why this metric is so important is because it is a measure of how easy or difficult it is for a first time homebuyer to buy a house. Unlike families that already own a house and are looking to upgrade, first time homebuyers don’t have an existing home to sell when looking to buy a new one. As a result, first time homebuyers don’t have the ability to benefit from home appreciation and roll that equity into their next house. This means that unless these first time home buyers get financial help from family members, their only source of generating the funds required to purchase a house is through their income. The bigger the difference between the median household income and the average house, the more the typical family has to really stretch their finances in order to buy a home.

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