The 5% Rule for Rent vs Buy

The quick formula

Real example

Property for sale: £350,000
Rent for similar property: £1,400/month = £16,800/year
Calculation: (£16,800 ÷ £350,000) × 100 = 4.8%
Result: Below 5% → Buying is financially favored

Alternative property: £450,000
Rent for similar property: £1,800/month = £21,600/year
Calculation: (£21,600 ÷ £450,000) × 100 = 4.8%
Result: Below 5% → Buying still makes sense (barely)

Why does this matter?

If you buy at a 4% rental yield and can invest your rental income (or your down payment money elsewhere) at 6% stock market returns, buying wins. If you buy at 6% yield, renting and investing the down payment money wins. The 5% threshold roughly breaks even with other investments.

Below 5% = buy. Above 5% = rent. This isn't precise — it ignores maintenance, taxes, insurance, appreciation, leverage amplification, and transaction costs. But it's a useful mental shortcut to avoid terrible decisions.

Common mistakes

• Using average rent instead of comparable rent: Don't use "average rent in London is £1,600". Use actual rent for a property like the one you'd buy.
• Forgetting interest rates: At 2% mortgage rates, buying at 5% yield works. At 6% rates, the 5% rule breaks — your mortgage costs 6% but the house only yields 5%.
• Using the rule in booming markets: If property prices rise 10%/year, even a 2% rental yield might work because appreciation does the heavy lifting. The rule stops working in rapid-growth markets.

When the rule breaks

• Young, rapidly appreciating markets: London, San Francisco, Austin. Prices climbing 8-10%/year. Rental yield is 2-3%, but total return (2% rent + 8% appreciation) is 10%+. Buy despite low yield.
• Declining or stagnant areas: Post-industrial towns. Rents rising faster than prices, or prices falling. 7% yield sounds great until the property drops 30% in value.
• Tax treatment varies: UK landlords claim mortgage interest as expense; US landlords claim depreciation. Same property, different tax burden, different breakeven yield.