By Stanton Kensinger
As dental service organizations gain popularity, single-tenant buildings favored by solo practitioners may fall through the cracks when it comes to sales. This company created the co-op concept to help dentists avoid this dilemma.
The dental industry is changing, and trends point to a decline in dentist-owned private practices and strong growth of the dental service organization (DSO) business model. Last year, the American Dental Association published an article on shifting practice configurations that noted this trend, which is especially strong among young dentists. Overall practice ownership fell from 84% in 2005 to 78% in 2017. Among dentists under age 35, practice ownership decreased from 44% to 28% during the same time period.
Dentists join DSOs for many different reasons. For some, it’s about finding a better work-life balance. Others, especially young dentists, are looking for ways to decrease their education debt. Some dentists join a DSO to steer their careers in a new direction or to make the first long-term move with an eye toward retirement. Many value the security that comes with joining a large organization rather than going it alone or taking on partners.
Whatever the reason for joining a DSO, if a solo practitioner or group that is joining the organization owns the building where they practice, the property is typically sold. Private equity investors usually buy the buildings that group affiliates will use as their practice location. But dentists who owns a single-tenant building can have a more difficult time attracting investors, which puts them at a financial disadvantage.
A new concept called a dental practice real estate cooperative (co-op) from Professional Transitions Strategies (PTS) can help.
Co-op can lower the cap rate
So, why do single-tenant buildings tend to fall through the cracks? It’s a question of capitalization (cap) rates. Group practice property is generally considered a safe bet since it’s backed by a large investment portfolio. The same principle applies to other types of businesses. From an investor’s perspective, a restaurant occupied by a chain is a safer bet than a mom-and-pop shop. As more dentists join DSOs, more single-tenant building owners will encounter this conundrum.
That’s what gave the PTS team the idea to create a co-op. We work with dental practice buyers and sellers and leading DSOs across the US, so we’re in the unique position to form a co-op that can help dentists who own a single-tenant building get a better financial outcome. That’s important because for most dentists who own their practice building, their commercial property is their second most valuable asset aside from the practice itself. They need to get the most out of their real estate investment.
The idea behind the co-op is simple: dentists who are joining a DSO can retain part ownership of their property and lower their cap rate by participating in the co-op, which bundles their property into a larger private equity-backed portfolio. This can significantly reduce their cap rate, making the property more attractive to investors.
Why the cap rate matters
A lower cap rate makes a property more attractive to investors because the cap rate is a formula used in real estate investing to measure risk. The formula divides the annual income of the property by its cost or value to determine the risk level. So, the lower the cap rate, the more likely the property is to provide a good return on the investment, and the more attractive it is to investors.
To return to our restaurant example, if a commercial real estate investor were considering two identical properties—one occupied by a mom-and-pop Mexican food restaurant and the other by a Taco Bell—the cap rate would be lower for the chain restaurant property, making it a more attractive investment. Co-op participation gives dentists who own a single-tenant building and plan to join a DSO similar marketplace clout because their property becomes part of a larger portfolio, like the Taco Bell.
To use another analogy, the PTS co-op bundles dental practice properties in a way similar to how DSOs bundle the practices themselves. The selling dentist keeps a stake in the practice via a joint venture agreement and sells over time. In this way, the property becomes part of a co-op portfolio containing strong leases with multiple long-term tenants generating hundreds of millions of dollars per year. That’s more attractive to investors than a single-tenant practice that generates half a million annually.
We’re not aware of any similar co-op concept available in the dental industry, but we think the idea will gain momentum because it meets an urgent need. As DSOs gain traction, dentists who own a single-tenant property will need a way to maximize the value of their real estate, and the co-op can help by potentially reducing the cap rate from the 8.5 to 10 range down to 6.5 to 7. That can make a big difference to dentists who are thinking about joining a DSO. Learn more about co-ops here.