The 5% Rule: Guide to Buying Vs. Renting a Property
Sunday Feb 27th, 2022
Buying a house will probably be one of the most important decisions in your life. It requires a significant deal of emotional energy, market knowledge, and capital income. Everybody knows that housing is not solely about a financial decision. Rather, it is about your sentimental attachment to a place and the mental peace of living somewhere you can enjoy.
Most homeowners would agree that buying a house was the best decision they ever made. However, a lot of people lack the vision to consider renting a property instead of diving into buying it immediately. Moreover, there is a stigma surrounding renting a property because it is not your “own”.
Today, I will discuss the decision between buying a house or renting it. This way you can come up with a real estate plan in no time, and strategize to maximize.
One of the best ways to decide whether buying a house is the better decision or renting it is by calculating the cost of living in both of these places individually. A real estate investment in the GTA is a great investment, and I’m here to help you determine which one is the best. While it is easy to calculate the cost of living in a rental, calculating the cost of living at your own house can be tricky.
Living in a rental cost you as much as the rent does. However, living on your property can come with other expenses. We divide these expenses into three categories:
1. Property tax
2. Maintenance costs
3. Cost of capital
A simple calculation that can solve the entire debate surrounding rent vs. buy is the 5% rule. This rule compares the cost of living at your house to living at a rental. Let’s see how much these three categories contribute to the 5% based on my knowledge as a real estate investment expert.
The first part of the 5% rule comprises property tax. This tax is equal to around 1% of the value of the house.
The second part of the 5% rule involves maintenance costs. These costs account for the other 2% of the value of the house.
The last part of the 5% rule is the capital cost. The rest of the 3% is made up of the cost of the capital.
Now let’s try to break down the capital cost and calculate it accordingly.
1. The first step is to put down a down payment in cash which is needed to buy a house. This is equal to 20% of the value of the house. The rest of the 80% can be financed using a mortgage.
2. The formula for the cost of capital is as followed.
Cost of capital = cost of debt + cost of equity
3. Here, the cost of debt is equal to the down-payment and the cost of equity is equal to the mortgage. By putting in the values, you can easily calculate the cost of capital.
In action, the 5% rule works by:
· Multiply the value of your home by 5%.
· Divide by 12.
· The result is the breakeven point, where renting is financially equivalent to buying.
So if you could rent an equivalent home for less than the monthly breakeven point, you should rather rent a property. But if it would cost you more than the monthly breakeven point to rent an equivalent home, you should buy a property. All you need to do at the end of the day is have a plan. I would love to help you figure this out, and what next steps would serve you best. Contact me for a consultation today