The concept of “highest and best use” is crucial to living our lives to their fullest. All of us live our lives with constraints of time, money, skills, capabilities and other resources. Our quality of life depends on how efficiently we leverage our constrained resources. We MUST get it right because if we don’t, we waste significant portions of our lives, work too hard, work too much and don’t get to do the things we really want to do while we still have the temporary gift of life on earth.
In fact, if you think hard about highest and best use of each your available resources, even for just a few minutes, you are much more likely to live the life you want and even achieve dreams you might not have thought were possible. If you think that statement is hype, you are probably right because of your limited belief. But if you analyze highest and best use of resources, like I do, you can turn dreams into reality, like I have.
The best way to introduce the concept of highest and beat use is to illustrate with examples. Since most of you reading this article are real estate investors, let’s start with examples from the world of real estate.
An example of highest and best use of real estate is when someone buys a piece of raw land that is a corner lot. Should the owner build a house, a bar, a pharmacy, a gas station, a house of ill repute, a hot dog stand, an urgent care facility, a daycare center, a Seattle-based coffee shop, something else? The answer is ‘it depends’ and the decision of highest and best use should be evaluated specifically for that location, demographics, economics, environmental, goals of the owner and other situational factors.
Let’s say that you want to open a convenience store on a main thoroughfare in the suburbs of a large city. Do you think it makes a difference which side of the street you site your store? One factor in the highest and best use analysis shows that more people will stop to buy milk and similar small items on their way home, not on their way to work. Since it is time consuming and a hassle to make a left turn on a main thoroughfare, the right side of the street in the direction away from the city is often a better choice. In contrast, a doughnut and coffee shop will see more business in the direction toward the city if the concentration of jobs is higher in the city than in that suburb. Highest and best use analysis for real estate can take seconds in some cases or can take years in other cases including multiple complex analyses.
Examples of highest and best use of money in real estate include deciding whether to do mortgage acceleration, Roth conversions and the BRRRR strategy. There are many more, but these three examples will get the point across.
Mortgage acceleration is almost always a highest and best use decision since the maximum monetary ROI for accelerating a mortgage is the interest rate of the mortgage loan. Do the math and you'll see this is true. If you can’t achieve a higher return than the interest rate on that loan, then mortgage acceleration might make sense. Most real estate investors can easily outperform the interest rate on a mortgage loan by investing in higher and better use real estate investments.
Don’t forget the time value of money when considering mortgage acceleration. Remember that the payments you avoid 10-20 years from now (which is when you save the most), are of money that has much less value than today. On the other hand, if you are in “consolidation mode” to simplify your investments (e.g., increase $ per tenant to minimize management) instead of “accumulation mode” (building your empire), then mortgage acceleration might serve you better so you can achieve higher cash flow with fewer rental properties when the mortgage loans are fully paid off.
Roth Conversion: If you are 60 years old, skilled in real estate investing and avoid doing Roth conversions because of the pain of shoveling money into the IRS coal box, you really need to do the arithmetic to understand highest and best of use of your money. You will usually find that the decision is a slam-dunk if you have cash that you can allocate for Roth conversion. Most real estate investors in this situation do not do Roth conversions and it’s because they simply don’t invest the minutes required to do highest and best use analysis. That's a real shame and I see it all the time.
For example, in one of my lectures in the Smarter Investing home study course, I show how a 2-deal sequence that started with a $75,000 Roth conversion (plus $7,000 in previous Roth funds) created in less than a year a whopping $176,000 of tax free equity in a single family home rental that generates more than $1,000 per month of tax free passive income! The returns are not only outstanding in the short term, the ongoing tax-free passive income in my retirement plan from this rental and other similar rentals in my Roth, is a cornerstone of my financial plan and financial freedom. When people see the actual numbers and how standard these deals are, especially for baby boomers who “find ‘em and fund ‘em” with others doing the work, it becomes painfully obvious that people who do not do Roth conversions from their significant pre-tax IRA or 401(k), are wasting precious dollars. It amazes me that others do not invest the time or minimal investment in training to understand this crucial highest and best use of money to achieve financial freedom in a highly efficient manner.
The Buy-Renovate-Rent-Refinance-Repeat (BRRRR) strategy is one of the key strategies used to build a small or large empire of rentals. The basis of BRRRR is highest and best use of cash and OPM. On the other hand, if the rentals have relatively low cash flow, then the cash flow per month per door