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Rent under 5% beats buying
The five percent rule
The 5% bundles the costs of owning that never come back. Property taxes run roughly 1% of the price each year, maintenance roughly another 1%, and the cost of capital, which covers both mortgage interest and the stock returns the money tied up in the house could have earned, is put at 3%. Both the maintenance and the opportunity cost figures are on the low side.
A worked example
Take a $300,000 house. Times 5% is $15,000 a year, and divided by 12 that is $1,250 a month. Any rent at or below $1,250 makes renting the better financial decision, with the difference between rent and the owner's cash costs invested in the stock market.
What shifts it
It is a rough rule of thumb, and the inputs shift it. A more conservative or more aggressive investment mix changes the opportunity cost. For someone taxed on investment gains, the after-tax return on stocks and bonds is lower, so the opportunity cost of owning drops and the break-even moves toward owning.
Why do property tax rates differ so much?
According to the Tax Foundation, effective property tax rates in the United States range from roughly 0.3 percent of home value in Hawaii to more than 2 percent in New Jersey. Local governments set the rates and use them to fund schools, roads, and other services. Because bills are tied to assessed value, rising prices can lift the bill even when the rate stays the same. Canadian municipalities work the same way, with rates set city by city.
How much does a house lose to wear each year?
A 2007 study by Harding, Rosenthal, and Sirmans in the Journal of Urban Economics estimated that a house loses roughly 2.5 percent of its value a year to physical depreciation, which maintenance partly offsets. Land does not wear out in the same way, which is why price changes for the lot and the building can differ.
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