Should You Postpone Purchasing A Practice Due To Higher Interest Rates?
October 2022 ISSUE October 1, 2022Transitions Buying/Selling and Mergers
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Inflation has been raging at near record levels over the past year. In response, the Federal Reserve has been dramatically increasing interest rates to get it under control. Home mortgage interest rates have risen from the 2-3% range in early January 2022 to 6-7% currently, while interest rates on practice-related loans have jumped from around 3% up to 5-6% or higher.
As a result of these higher interest rates, many young doctors believe the risk associated with buying a practice has increased. Further compounding the perceived financial strain is the threat that the moratorium on student loan debt repayment is scheduled to end soon. Considering these factors, more young doctors are asking: “Should I delay purchasing a practice until interest rates come down?”
From an emotional standpoint, these concerns are reasonable. Unfortunately, making financial decisions based on emotions can have devastating results. We asked Roger K. Hill* to prepare a financial analysis to determine which course of action achieves the best results.
Hill illustrated two scenarios, based on purchasing a practice collecting $1,250,000 with a 60% overhead ($750,000) and a 40% profit margin ($500,000) at an assumed purchase price of $1,000,000. Under the first scenario (immediate purchase), the practice was 100% financed with repayment over 10 years (120 months) at the higher interest rate (5%) now in effect.
In the second scenario (purchase delayed by one year), the young doctor simply worked an additional year as an associate at a salary of $180,000, before purchasing the practice. The purchase price, terms, and conditions were the same, except the interest rate was projected to drop to 3%.
Which option provided the best financial results? Hill noted the after-tax cash flow generated by purchasing the practice now was $137,280 greater than under the delayed purchase scenario. Furthermore, the incremental earnings on the additional cash flows generated was $60,616 higher under the immediate purchase option. Accordingly, the immediate purchase option produced an additional $197,896 in cash flow.
Why did the immediate purchase option provide the best financial results? In summary, it’s because the practice purchase option provided a 40% profit margin on the total collections, including doctor and hygiene production, from which the purchaser benefited immediately. In the delayed option scenario, the potential purchaser worked as an associate for an additional year, earning a lower compensation (typically 25% of doctor production only), thus receiving a dramatically lower economic benefit.
So don’t let higher interest rates dissuade you from making the right economic decision. Purchasing a practice at the right price now is your best bet. It not only increases your after-tax income (cash flow) immediately, but also allows you to begin building wealth (practice ownership value) sooner.
*For more information on dental practice transition services, call 704.424.5626 or connect online.
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