Rehabbing a Foreclosure? Spend This Much

By Joanne Y Cleaver | Updated Aug 17, 2013 10:14 PM

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Rehabbing a Foreclosure

Quality home renovation got a shout-out from Wall St. recently with Morgan Stanley analyst Oliver Chang recommending that investors spend 25% of the purchase price of a foreclosure on subsequent renovations.

Why does Morgan Stanley care? Because lenders own millions of homes (that’s REO—or “real estate owned”—for us non-Wall St. types). Though the first quarter saw a lull in the foreclosure rates, a second tsunami is building, predicts real estate data dealer RealtyTrac.

If you’ve been circling the foreclosure market hoping to snap up a bargain, you are up against agents armed with buckets of cash from institutional investors. The National Association of Realtors (NAR) estimates that about a third of home sales are all-cash (i.e., purchased on behalf of investors).

Typically, foreclosures need more than cosmetic touch-ups.  Angry homeowners often destroy the places on the way out, ruining everything including the kitchen sink.  And,  homeowners who couldn’t pay their mortgages rarely spent on basic maintenance, which means that the mechanicals and appliances of foreclosures must be carefully inspected before you turn your attention to finishes, updates and curb appeal.

But institutional investors are in it to make money. The Morgan Stanley 25% guideline shows how they do it:

Rent: 15% of total cost (purchase price + rehab cost)

Property tax: 22% of rent

Property management: 5% of rent

Maintenance: 5% of rent

Turnover (cost to acquire new renters): $2,000 per turn

To monitor foreclosures in your market, and for in-depth guidance on wading into foreclosures, check out the resources at real estate data firm RealtyTrac.

For more on foreclosed homes and remodeling, consider:
10 Things to Consider Before Buying a Foreclosed Home
Quick Tip: “Budget-Smart” Bathroom Remodeling
How To: Paint Like a Pro