Interest Rates & Practice Values
You may have seen it in the news: interest rates are about to go up. And if you’re thinking about buying or selling a dental practice in the next few years, it’s time to pay attention.
This is the first in a series of blog posts exploring the market forces that drive dental practice values. Of course, the best way to increase your practice’s value is to improve its profitability. The more money you make in your practice, the more your practice is worth. But some of the variables that determine price are beyond your control.
One of these variables is interest rate. The basic reason is simple. When borrowing money is cheap because of low interest rates, buyers can afford to buy a bigger practice. Money has been cheap for almost ten years now, but it’s about to get more expensive. It’s therefore likely that practice values will be decreasing.
But things aren’t looking rosy on the buyer’s side either. While it might make sense at first to wait for practice values to decrease, this is probably not the best strategy. When interest rates go up and borrowing money becomes more expensive, the actual cost to buyers also increases.
Let’s explore this in more detail.
As you know, interest rates tell you how expensive it is to borrow money, or, in other words, how much you will have to pay to the person or institution with the interest in the loan.
The rates that regular folks receive when they go to borrow money depend on the rate at which banks can borrow money, and those rates are set by the Federal Reserve, an independent institution created by Congress in 1913 to address bank panics. These days, the Fed works to promote a healthy economy and banking system.
One of the roles of the Fed is to address inflation and stagnation by adjusting the rate banks can charge each other for overnight loans. These rates filter down, both directly and indirectly, to affect the interest rates attached to loans for dental practices.
While monetary policy is complicated and goes beyond the scope of this blog post, what you need to know is this: since 2009, interest rates have been set at historic lows. Now the market is bracing for them to go up.
What does this mean for practice values?
The interest rates attached to loans affect how much practice a buyer can afford. Higher interest-rates lead to higher monthly loan payments for buyers, thereby reducing the potential cash flow to a buyer of a given practice. This reduces buyer-purchasing power, disqualifying some, and reducing the overall number of available buyers in the marketplace.
Imagine that you’re looking to purchase a practice for $600,000. A 10 year note for $600,000 at 4% interest will cost you $728,964 over the life of the loan. The same loan at 8% interest will cost you $873,558.
That’s a difference of $144,594! The difference in monthly payments is $1,205. This means that the doctor who borrowed at 8% has to earn an extra $1205 each month to take home the same amount of money as the doctor who borrowed at 4%. These market forces clearly affect what buyers can or will pay.
When interest rates go up, monthly debt service increases. If debt service goes up by $1,000, the buyer’s net income decreases by $1,000. Lenders are acutely aware of the additional drag on cash flow due to higher interest rates and they loan correspondingly lower amounts, which also drives down practice values.
Here’s the bottom line. If you’re thinking about buying or selling a dental practice, consider selling it now, before the market starts reacting to the changes on the horizon. And if you’re ready to buy or sell now – or just have questions about your options – Integrity Practice Sales is here to help.