So a player has asked whether or not I would allow him to buy permanency flight for his character at level 5. He agreed to put a limitation on it similar to illusory flight, but it would still be a 60 foot fly speed with good maneuverability. Also as a level five character he would be spending nearly all of his gold (10,000) in order to do this leaving him with the inability to even buy a +1 weapon. I have bounced between saying this is completely not allowed to that is totally not overpowered. Please help me sort out whether or not this is overpowered.
Such an effect is both too powerful in terms of usual problems with flying characters, and too vulnerable to easy loss. Both of these things make it a headache to DM for, and not worth considering
The problems with early at-will flight in terms of power are spelled out elsewhere, but in brief:
Easy way to avoid melee combat for ranged characters. Most monsters encountered at 5th level will have very limited ability to deal with a flying PC.
Easy way to circumvent typical dungeon and travel hazards encountered in "heroic tier" play
One flying PC in a group of non-flying PCs will frequently have reasons to separate in order to scout, run messages or solve other problems that they find much easier and faster than their team mates.
The other problem with the specific route that the PC is choosing is that the permanency effect can be easily removed. A Dispel Magic would do it. At higher level, this is a balancing issue with Permanency - having permanent enchantments on the character is a great benefit, they can be lost, but the PC will have other magic and abilities, they don't have all their eggs in one basket.
Any character using permanent spells to augment their character risks losing the extra abilities when encountering certain enemies. If a wizard NPC sees a magically flying character causing problems for the bad guys, then it is perfectly rational for them to attempt to Dispel the Fly. However, for your player this will now appear as an incredibly aggressive, targeted attempt to nerf their build. So in essence you cannot do it, the player has set up a vulnerable build that is "too big to fail". There are other ways to do the same in D&D 3.5E, generally they involve the player putting all character resources into a specialist power and leaving themselves so defenceless against a specific counter that it cannot be used against them and the game remain fun.
The game thinks it's a bad idea at this level to spend this amount of wealth on a lone effect
On Designing Encounters on Placing Treasure says
Table: Character Wealth by Level can also be used to budget gear for characters starting above 1st level, such as a new character created to replace a dead one. Characters should spend no more than half their total wealth on any single item. For a balanced approach, PCs that are built after 1st level should spend no more than 25% of their wealth on weapons, 25% on armor and protective devices, 25% on other magic items, 15% on disposable items like potions, scrolls, and wands, and 10% on ordinary gear and coins. Different character types might spend their wealth differently than these percentages suggest; for example, arcane casters might spend very little on weapons but a great deal more on other magic items and disposable items.
(Link and emphasis mine.) While a GM can ignore this suggestion—just like the GM can ignore any suggestion or any rule, for that matter—the game seems to expect folks follow its suggestions. So, while deviating from these suggestions won't necessarily lead to an overpowered character (although it can), deviating from them has a much greater potential to lead to an unbalanced character… like a character who must rely heavily on other party members during encounters when he's not dominating encounters.
The accommodations being made for this character are excessive
"The GM may allow other spells to be made permanent," says the spell permanency, but the GM doesn't have to. Further, allowing an effect like even illusory fly to be made permanent using the permanency spell is something pretty much every creature that can't fly will want as most other forms of long-term flight are far more expensive.
(I suspect the player in the question has already realized even at the 10,000-gp price point, he's getting this ability for his PC on the cheap, but increasing the cost to the nonstandard 10,000 gp from the standard 7,5000 gp established by the cost to make the spell arcane sight permanent does very little to mitigate this ability's long-term value. Even making the PC pay the level 11 wizard another 550 gp to cast the spell permanency and 330 gp to cast the spell illusory fly doesn't really reduce the value of this ability either, those being trivial costs for a PC of but one level later.)
But with this seemingly modest accommodation, the campaign's metaphorical and actual landscape changes. Every creature that can scrounge up 10,000 gp will buy this ability, and although the PCs won't really feel the full impact of this change until their NPC foes are likely at least level 11, before then, those level-11-or-higher NPCs have already had access to this ability and they've used it and that changes the campaign!
To analogize, every high-level NPC had and has now an invisible, unregulated, no-fuel-needed builtin jet pack. The long-term campaign effects of this are staggering. If the GM's building a campaign that's to have any kind of verisimilitude, the GM must devote a lot of time to assessing the impact of this seemingly small change.
If the ability to apply the permanency spell to a fly spell is a recent discovery or if the PC is a super-special snowflake, few campaign-scale accommodations need be made, but, even then, such a radical magical breakthrough should make the PC a target for all sorts of folks who want to duplicate the breakthrough! Hence it's possible that in addition to having an unbalanced PC that can occasionally dominate encounters alone by pinking away at foes with his free sling and free rocks, the PC has possibly just put himself at the center of one of the campaign's major plot points! His unbalanced PC gets even more attention: not only does the PC always play the flying game so the GM must always plan for the PC to play that game, the PC's fellows either only occasionally play the flying game or don't play the flying at all yet… , but also important, powerful folks will be hunting for Flying Man!
Find out why the player wants the PC to fly then offer alternatives
It's one thing to change the campaign world to accommodate PCs players want to play. It's another thing entirely to change how the other PCs must play to accommodate one PC. For this GM, that would be a bridge too far. Nonetheless, this GM would try to find out why the player wants this ability for his PC.
If it's because the player thinks all aspects of his PC are covered except mobility, then this GM would suggest the player rethink his approach to character design. Pathfinder characters are not supposed to be super-powerful Swiss army knives, capable of handling every situation with equal vigor and aplomb. That is, if flying forever is the PC's final stop on his path to ultimate invulnerability or whatever, this GM would discuss the disconnect between the game's expectations and the player's expectations.
If it's because the player has a wacky scheme that hinges on the PC flying all the time, this GM would ask the player for details of that wacky scheme and evaluate not the permanency/illusory fly combination but the wacky scheme: nixing this combo merely delays instead of addresses the scheme. So if the player plans to win Pathfinder by always dropping rocks on his foes or whatever, this GM would hash out the rule (or, perhaps, loophole) the player's planning to use (or, perhaps, exploit).
Finally, it's possible the player only wants his PC to be able to fly all the time because flying all the time is just awesome! This GM would have no trouble telling the player that it's simply inappropriate at level 5 for the PC to fly forever. This GM would point to established baselines like the feats like Angel Wings (which has as one prerequisite being a level 10 character) and Wings of Air (which has as one prerequisite being a level 9 character) and magic items like the wings of flying (which cost 54,000 gp) or the demonic implant wicked wings (from the Pathfinder Adventure Path #74: Sword of Valor 74 and which cost 55,000 gp ).
Alternatively, the GM can point to a race with a native fly speed like a gathlain, strix, syrinx, or wyvaran and either recommend the PC instead be a member of such a powerful race (so as to demonstrate to the player that such an ability usually requires expending a resource different from mere wealth) or use these races fly speeds as examples of a feature a member a member of a more typical race with a lower race point value should not possess.
…And take everything with a big ol' grain of salt!
Many of the suggestions above may seem to hinge on the game itself being reasonably internally balanced but, in fact, the game is not. Game balance relies instead on the GM developing through experience his own instinct for balance with regard to the GM's own campaigns.
For example, a campaign in which all the other level 5 PCs are already flying forever won't be harmed by a new PC who can also fly forever! Likewise, in a dungeon crawling campaign consisting of exclusively 5-ft.-tall×5-ft.-wide corridors leading to 10-ft.×10-ft.×10-ft. rooms, such a PC will likely find his ability to fly forever occasionally useful but not particularly powerful. However, a campaign consisting entirely of outdoor wilderness adventures may be wrecked by one PC that can fly forever. First the GM must evaluate his own campaign and then the GM can determine if a special ability is appropriate for it.
Fly is a third level spell so the ability to fly is not inherently too powerful, but permanency is vulnerable to dispelling (with consequences such as potentially deadly falling damage and losing wealth, in this case).
Whether this is acceptable to you depends on the way you run the game.
Sequence of tailored challenges
If you run the game mostly as a sequence of balanced encounters, you are essentially responsible for that balance and the fun in the game. This would make the continuous fly ability bothersome - you'd have to constantly design around it and dispelling it would be an act you, the GM, did, and as such kind of a jerk move.
You can, of course, you an opponent with the ability to dispel, but you need to foreshadow it so the players know what they are getting into; then the encounter becomes one of stopping the dispel from happening.
I would recommend against allowing it.
Sandbox with player freedom
If you run the game as a sandbox, without any assumption of balanced encounters or threats, and with the players aware of this, then you can allow the permanent flight. It will change the nature of the game, but since you as a referee are not responsible for the choices, reckless or not, of the players, it is okay. You also do not tailor the challenges for them, so maybe they happen to encounter someone with dispel magic, maybe not, and maybe they decide to use the dispel magic, maybe not; play will tell.
You should allow a knowledge (arcane) check by someone, and with high enough result you should warn them about dispel magic. With a low result, you don't need to warn.
Using all their wealth in such a manner is a high-risk gamble, but one the player might be willing to take. So let them.
This player is trying to put all their eggs in one basket
If you allow this, a single dispel will strip the player of most of their wealth. This leaves you, as the DM, having to choose between allowing the player to lose everything to the next level 6 arcane caster they fight or avoid putting the party against such threats.
This choice isn't overpowered, but you should forbid it because it's so weak you'll need to shape far too much of the campaign around not destroying the character.
Instead, perhaps you could consider allowing them to buy winged boots at level 6-7.
I wanted a character with some early flight ability. I found that most of what I was looking for was fulfilled by the Ring of Seven Lovely Colors (http://archivesofnethys.com/MagicRingsDisplay.aspx?FinalName=Ring%20of%20Seven%20Lovely%20Colors)
It's fairly cheap, grants access to flying several times a day, but doesn't really lend itself to combat or long flights.
I had a similar situation where a player would use overland flight to avoid all combat. As an archer, he would be what was described above (correctly) as a fuel-less jetpack and he would rain death on everything.
One time, I brought him down to below 0hp, he plummeted to the ground, took Xd6 damage and died (the fly skill does not make you feather fall if you fall unconscious).
He was rather annoyed when the rest of the party clapped with joy.