THE ABSURD ESCALATION OF PRACTICE VALUES – Has the market crashed?

Global events of March/April 2020 were not predicted when this article was first published in February of 2020

Updated: April 12th, 2020 – 1:15 pm EST

By Timothy A. Brown, FRI, CEO & Broker of Record www.roicorp.com

I rubbed my crystal ball a couple of years ago and said that practice values had peaked. My opinion was based on the financial metrics we use to guide logical purchase prices based on the earnings method and the ability of the purchaser and the practice to service debt and repay the price paid over a 10-year period.

I was wrong. The last two years have seen a continued increase in practice values due to the top three Pillars of the Supply/Demand equation:

1. Demand is over-heated (and escalating) at a faster rate than expected due to the number of dentists entering Canada from other nations and their ability to challenge the National Dental Examining Board for up to three times before they are eliminated. They are getting better at passing the exams and the pass rate is going up. Accordingly, there are many additional dentists entering the major cities of Canada that I had not anticipated. They are highly motivated and very capable. Preferably, they do not want to start a practice from scratch and they do not want to associate for somebody. They are business owners from other nations and they want to be business owner here. The result of this is a highly motivated group of practice buyers. To add to the demand-side we now witness a sudden surge in demand from Associate dentists. Many are idle and predict that when reopening occurs, the owner will absorb the schedule and not ask the Associate back to work for another 2 or 3 months while the return to ‘normal’ is in formation. Considering that many Associates been out of work since March 15th, it will be 4 to 6 months before they are invited to return and likely on a limited schedule. Not a good prospect for those with student loans, mortgages and young families.
2. Supply is short (Hyper-Scarcity) of practices on the open market. This scarcity is largely due to corporate service organizations with their deep pockets and their insatiable demand acquiring numerous practices. They are in a race against each other and it is much like McDonald’s, Burger King and Wendy’s as they compete for market share. That means the owners of practices in Canada are receiving absurd offers to sell their practice, although many are turning them away for reasons that are not the topic of this column.
3. Ample, free flow of capital (hyper-low interest rates). Prime rate is 2.45 per cent and the incredible access to credit that most health care professionals enjoy stimulates and lubricates the market. Personally, I think that the banks are lending too much money—to professionals who are too young and to those with limited or no business experience whatsoever. Because these loans are personally guaranteed and the banks are often assigned life and disability insurance coverages on these loans, their actual risk for this type of lending is quite low. That is why they continue to lend, even during shut down. The absolute loan loss ratio for health care professional loan portfolios in most of the major banks is one of the lowest. Most professionals never want to declare bankruptcy thus most will do anything required to repay debt.

These three, empirical determinants are the key indicators of value; high demand, short supply and low interest rates. No other influences, such as stock or real estate market fluctuations, emotions or anxiety will outweigh these three powerful levers.

Logically, practice values peaked two years ago. Practically, they are probably going to go up again by the end of 2020 by another 3-5 per cent. I know, it makes no sense to say this in April of 2020.

People want the experts to make predictions and it can be good sport following them. Knowing that the expert can be right as often as he/she is wrong is the gamble we make when we follow an expert. Once the results are known, the naysayers like to call out the predictors when they are proven to be wrong.

Are you bold enough to make a prediction right now?