Highest and Best Use of Capital Part Three: Investing for Good

Tim Milazzo
November 13, 2023

Real estate for good

Capitalism, aka seeking the most profitable use of capital, is itself a good thing as long as you are not wronging people in the process of making money. If you disagree, don’t @ me unless you’ve read some Thomas Sowell first so our debate isn’t boring.

The core idea with open markets is to allow Supply (“I have this”) and Demand (“I want this”) to meet and for there to be a mutual exchange of value. In a real estate context, the market sets the price for available space to rent or buy. Demand comes from the fact that people need places to live, work, and play, and that demand overcomes a massive amount of effort it takes to develop and operate physical buildings.

But not all demand is created equal.

The capital markets can, and do, compare the relative value of projects spanning very different types of demand at the property level “highest and best use”, as well as the portfolio and system level. We already explored how to maximize returns, and how to scale your real estate investment machine.

But we left off with the question:

Wouldn’t it be a shame to wait until the end of life to decide whether you were playing the right game?

Should a real estate investor always, only look to maximize their return on capital? Is that the right game?

All demand isn’t equal

Two projects are underwritten and both are projecting to the same financial returns. One is an affordable housing development, and the other is a strip club.

There’s a growing narrative in Western culture that landlords profiting from rental housing is wrong. Think about it this way: those real estate investors are providing a capital markets environment that leads to the development of more housing, which is filling the demand. Housing people is a societal good, and investment activity enables more housing.

A real estate investor profiting from a strip club is tapping into a very different type of demand, not a necessity and I would argue not something that is positive for society, but demand nonetheless.

So from an overly narrow capitalistic standpoint, those two projects may be “equal”, but as an investor you get to decide what type of demand you are satisfying by supplying real estate to your community.

Direct and indirect outcomes

We’ve seen that there are two (equal and opposite) direct outcomes of a real estate investment:

  1. Satisfying a community’s demand for physical spaces to live, work, play, and worship
  2. Return on invested capital

All other considerations that you don’t find on the bottom line of the spreadsheet can be considered “indirect” outcomes. If the direct outcomes are the “what”, many of the indirect outcomes include the “how”.

Lately, our industry has been cluing into some of these indirect outcomes under the banner of ESG, which stands for Environmental, Social, and Governance - softer measures of a project or company to determine whether it is “good” for the world. Even principled capitalists are leaning into this type of stakeholder analysis. Most recognize, despite perhaps the most Ayn Rand-discipled crowd (Rand argued that making money without violence or coercion is itself the highest good), that it is simply good business to clue into qualitative measures of success along with short-term profit.  As a matter of fact, both score points in the long-term profit game.

I rarely meet an investor who is wholly disinterested in the full spectrum impact their work leaves on their communities. But it is rarely a key focus.

There’s a movement of faith-based investors towards measuring impact beyond the bottom line which swings more into the realm of Ministry than ESG. Like the S and the G of ESG, a real estate leaders focused on Ministry key in on how people are impacted by their business or investment.

So while my previous post called this the third and “final” part in my series on Highest and Best Use, I did, in fact, lie. Real Estate as a Ministry is fourthcoming (highest and best puns later).

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