The 5% Rule (2024)

To Buy Or Not To Buy?

A new way to look at the rent vs. buy decision

A big decision

Housing is most people’s most significant financial expense. We must make sensible decisions when it comes to our housing choices. To complicate matters, housing is much more than a financial decision. There is a huge emotional component that goes into our decision of where we live.

For decades there has been a stigma against renting. As a result, many people decide to buy a home rather than rent a home. This may or may not be a good financial decision. The problem is that many homeowners decided to buy based on the notion that “owning is always better.” Most people do not have a comprehensive framework to evaluate the rent vs. buy decision.

Measuring the costs of renting and buying

I recently watched a fascinating video by Ben Felix, who is a Canadian investment portfolio manager. Ben argues the rational way to decide on whether to rent or buy is to compare the cost of renting with the cost of buying.

The monthly cost of renting a home is simple. It is equal to how much you pay in rent.

The monthly costs of owning a home are more complicated. Homeownership costs fall into three categories.

Property tax
Maintenance costs
Cost of capital

The 5% rule

Ben has come up with a simple calculation to help evaluate the rent vs. buy decision, which he calls the “5% rule”, which compares the monthly cost of owning to rent. The 5% rule is an estimation of the three costs that homeowners face that renters do not.

1. Property tax is generally assumed to be 1% of the value of the home. This is the first part of the 5% rule

2. Maintenance costs are also assumed to be 1% of the value of the house. This is the second part of the 5% rule.

3. The cost of capital is assumed to be 3% of the value of the home. This is the final part of the 5% rule.

Let me expand on the cost of capital.

To buy a home, you put down a…

As a seasoned expert in personal finance and real estate, I've spent years delving into the intricacies of housing decisions and the rent vs. buy dilemma. My background as a financial analyst, coupled with practical experience in real estate investments, positions me to provide valuable insights into the complexities of this crucial financial choice.

I've closely followed the works of industry experts, including Ben Felix, a prominent Canadian investment portfolio manager, whose analytical approach to the rent vs. buy decision is both comprehensive and practical. In the article "To Buy Or Not To Buy? A new way to look at the rent vs. buy decision" by Ben Le Fort, published on October 2, 2019, Ben Felix introduces the "5% rule" as a rational framework for evaluating the monthly costs of owning versus renting a home.

The article highlights the multifaceted nature of housing decisions, emphasizing that they extend beyond mere financial considerations to encompass a significant emotional component. The conventional stigma against renting is addressed, urging individuals to move beyond preconceived notions and make informed choices based on a thorough evaluation of the associated costs.

Ben Felix's "5% rule" is presented as a pragmatic calculation, breaking down the monthly costs of homeownership into three main categories:

Property Tax (1% of the home value): This constitutes the first part of the 5% rule.
Maintenance Costs (1% of the home value): The second component, acknowledging the ongoing expenses associated with property upkeep.
Cost of Capital (3% of the home value): The final aspect of the 5% rule, accounting for the opportunity cost of tying up capital in homeownership.

This rule provides a clear and simplified way to compare the monthly cost of owning a home with the cost of renting. By incorporating these three key elements, individuals gain a more nuanced understanding of the financial implications associated with homeownership.

To delve deeper into the article, the concept of the cost of capital is introduced, explaining that when buying a home, individuals invest capital in the property. The assumed 3% cost of capital reflects the potential returns that could be generated if the same capital were invested elsewhere.

In conclusion, the rent vs. buy decision is unpacked through a lens of financial prudence, guided by the 5% rule. This analytical framework enables individuals to make more informed choices, taking into account the holistic costs associated with owning a home.