Why are high cap rates risky

[Owen Thornton]

Why are high cap rates usually considered risky? Are they not profitable for their high returns? Or is it likely risky because the seller is selling even though there are such high returns?

Are high cap rates simply on average risky, though some may not be?

I am confused simply on: what part of the equation of a cap rate includes such risk?

Is the risk simply class and state of property?

[Frank Rolfe]

In general, mobile home parks follow the same "risk vs. reward" metrics as all real estate. In Sam Zell's book "Am I Being Too Subtle?" he says that you should always buy deals with high reward and low risk and never buy deals with low reward and high risk. So if you assume that all deals with high reward (high cap rate) must have high risk, then that's why you would think that any deal with a high cap rate must have above-normal danger to it. However, it has been our experience that many moms and pops price their property inappropriately so this formula is not always accurate. For example, if the seller has a deal with good infrastructure, density and location but has it priced too low due to poor knowledge of the market, then you have a high reward/low risk situation. We see this most often when the mom and pop have rents that are hugely below market (like a park we bought in Austin with $240 per month lot rents when the market was $550) and all you have to do to hit an insanely high cap rate is simply to raise the rents significantly.

The bottom line is that you should not assume that all high cap rates = high risk. That's only in a perfect market where pricing is accurate -- and most mobile home park pricing is anything but perfect.