To compare renting and buying honestly, you must compare like with like. Folk wisdom says rent is “money thrown away” while a mortgage “builds equity.” Half of that is correct: rent is indeed an unrecoverable cost. The dishonest half is the unspoken implication that owning has no unrecoverable costs. It has many, and most buyers never add them up.
Each year, ownership burns money you will never see again — money that builds no equity. A widely cited rule of thumb, the 5% rule, estimates this annual unrecoverable cost at roughly 5% of the property’s value, in three parts:
Varies sharply by state. California’s Proposition 13 pins the base rate near 1.1–1.2% of assessed value, with annual assessment growth capped at 2%. The SALT deduction relief written into OBBBA — a headline cap of $40,000 in 2025, growing 1% per year through 2029 before snapping back to $10,000 in 2030 — looks generous on the marquee, but for the readers of this book it largely is not: the cap is phased down by 30 cents on every dollar of MAGI above $500,000 (indexed), with a $10,000 floor, so anyone clearing roughly $606,000 of MAGI is back at the old limit. On top of that, OBBBA’s new “2/37” rule (section “Tax Deductions of The Mortgage Interest”) caps the tax value of itemized deductions at about 35 cents per dollar for top-bracket filers. Net effect: on a property-tax bill of any size, most of the outflow is genuinely unrecoverable.
A conservative long-run estimate of what it costs simply to keep the asset from degrading: roof, systems, paint, and the slow grind of entropy. Older or larger homes run higher.
The largest, most overlooked, and most rate-regime-sensitive piece. It has two halves: the mortgage interest you pay on the borrowed portion, and the opportunity cost on your own equity — the after-inflation return your down payment could have earned in a diversified portfolio instead of sitting in drywall. Express it as a weighted average so it tracks your actual capital structure:
where is the loan-to-value ratio, the mortgage rate, the effective marginal tax benefit on interest (zero if you no longer itemize, capped at 35% for top-bracket itemizers under the 2/37 rule, and zero on interest attributable to acquisition debt above $750,000), the equity share, and the real long-run expected return on a diversified portfolio. In a low-rate regime runs near 3% and the full unrecoverable cost sits around 5%; in a higher-rate regime it can easily double, and the 5% rule is then conservative by half. Plug in today’s actual mortgage rate, your real effective tax position, and a realistic forward equity premium; do not trust the historical number printed in any rule of thumb, including this one.
Write the annual unrecoverable cost of owning, , as:
where is the property value, the property-tax rate, the maintenance rate, and the blended cost of capital from the formula above.
The decision rule follows immediately. Compare with the annual rent on a genuinely comparable property. If rent is meaningfully below , the mathematically optimal move is to rent and invest the difference — that gap is real money you can compound elsewhere. If rent runs well above , buying is the cheaper way to consume that shelter. Note what is not in this comparison: mortgage principal. Principal repayment is a transfer from one of your pockets to another — forced savings, not a cost — so it does not belong in .
One benefit does sit on the ownership side of the ledger: imputed rent. By living in a home you own, you collect the rent you would otherwise pay a landlord — effectively a dividend you pay yourself, and one the IRS does not tax. That is a genuine advantage. But it is the return that must be measured against the 5% of unrecoverable cost above; it is not a license to ignore the cost. The rigorous, dollars-and-cents version of this comparison — built on net present value — follows immediately below.