Despite the myriad of regulation, legislation, contractual and funding changes that pervade the world of health professionals, the demand for dental practices and pharmacy businesses has proven to be surprisingly robust during the recent period of economic and market uncertainty and continues to outperform other sectors as the economy returns to growth. Rob Bower and Chris Mitchell, Directors of Eddisons Taylors, examine the continuing resilience of these two primary care businesses and some of the Valuer's considerations when providing advice for secured lending purposes.
It is clear from our monitoring of the market and our discussions with all of the main active specialist dental agents that values of NHS-dominated practices have noticeably increased within the last two years or so. However, the length of the normal due diligence process is such that evidence of completed sales tends to reflect prices often agreed three to six months (or even longer) prior to the date of completion. With the market being so fast-moving, it is arguably relevant to take into account the more recent potential comparable information in respect of practices which have either sold 'subject to contract' or have exchanged. Agents report significant demand for any NHS practices that might come to the market, with agreed sale prices often exceeding their own expectations, particularly for larger contracts.
The current improved availability of finance from a number of Banks keen to lend to the dental sector may also be a factor in the increased demand and the consequent rise in prices. Should this reduce, then there may be an adverse effect on the market. However, agents report that this is not the only reason for the rising prices, with many prospective purchasers willing and able to commit substantial equity to assist with funding an acquisition, perhaps by offering collateral security or with 'family money'. This sometimes enables acquisitions to proceed, irrespective of whether the Bank panel valuers report lower valuations (perhaps due to the lack of contemporaneous comparable evidence) than the prices agreed, or the Banks limit funding due to other lending considerations.
The increasing demand for NHS practices may also be a result of the forthcoming change in NHS dental contracts with the first prototypes being set up this year, with more to be added in 2017/2018 although the earliest date at which a reformed contract is expected to be the norm is not likely to be until 2018/2019. Whilst this may be a perceived uncertainty, market participants seem to be more concerned with making sure that they acquire a NHS contract in advance of the changes, rather than waiting to see what the changes might bring. In addition, the clear nationwide trend of reductions in UDA rates paid to associates, with the market norm now appearing to be below £10 per UDA, has assisted to increase the level of gross profit and EBITDA available to the prospective purchaser. We are seeing increasing evidence of new practice owners renegotiating associate rates downwards, particularly in University towns and cities where there is a ready availability of newly qualified associates to take up the mantle if those existing choose to leave. Indeed, many associates are now more inclined to look to purchase their own practices in order to safeguard their income levels and take control of their own destiny.
It should also be added that there continues to be an acquisitive appetite from the larger corporate operators such as IDH, Oasis and BUPA (although they are no longer the obviously highest bidders), an aspect which clearly adds more fuel to the fire.
Whilst it has always been important to focus on market evidence relating to the geographical locality of a particular practice, there would also currently appear to be a clear 'north-south divide'. The upward pressure on prices is more clearly evidenced in London and the South East. The indications are that this upward trend is spreading to the provinces and further north but the indicated time-lag in completed transactions, particularly in the north, will mean that this will not yet be fully apparent.
Market Values for dental practices will, of course, depend upon a number of aspects, including tenure considerations (freehold or leasehold); however, in order to aid comparison between evidenced transactions, it is usual to allow for a 'notional' or passing annual rent, whilst also analysing on either a fully managed or sole-practitioner basis, dependent upon the nature of a practice and whether or not there are perhaps any specialist elements.
The available evidence, therefore, suggests that we are currently in a rising market for NHS dental practices and that the evidence of completed transactions may not truly represent the current market value, the definition of which is the price at which 'an asset or liability should exchange on the valuation date'. The question of whether the current level of market activity and prices achieved is sustainable is open to some debate, although there would appear to be a very large number of purchasers participating in evidenced transactions, with no suggestions from any of the specialist agents that the recent market upturn is a 'flash in the pan'. Nonetheless, the ongoing position in this regard, particularly with regard to factors of supply and demand will need to continue to be closely monitored.
It is, therefore, paramount in a volatile market that the Bank utilises experienced and independent sector valuers such as Eddisons Taylors who are not only in a position to obtain fully up to date evidence of all of the available market transactions but are also able to fully analyse these. In this respect, we are aware that many dental practice transactions are often 'conditional', based upon partnership entry (to assist the transfer of a NHS GDS contract), earn-out arrangements or the 'locking-in' of a vendor or key associate to maintain goodwill levels (particularly where there is a significant private element). The price achieved under these 'conditional' arrangements may not, therefore, constitute an 'arms' length' market value that would be available to the Bank if they had to realise their security. In addition, some practices' fee income may be overstated due to additional income received under the contract for a VDP (Vocational Dental Practitioner), a temporary 'top up' contract or where there is a level of risk due to under performance of the required UDAs. There is also the extra complications of other contracts for orthodontics, sedation etc.
The market for Pharmacies in the United Kingdom is divided between smaller and larger units, with the latter being sought-after both by regional groups and corporate operators who will need to see a turnover approaching £1,000,000. Larger shops are capable of supporting the cost of a full time pharmacist and still give a reasonable return with external management.
Demand for pharmacies has traditionally been primarily turnover-driven (particularly in respect of those with a strong NHS prescription element) and the presence of accommodation above is of less importance than is the case in other retail shops, for example, a newsagents.
Central Government seems keen to utilise local pharmacies to promote good health and to avoid pressures on general practitioners and this may offer opportunities to pharmacists especially those looking to invest in their premises via the provision of consulting rooms etc. Generally, the pharmacy market might be vulnerable to changes in NHS/Government policies and, given the purchasing power of the NHS, there is little that pharmacies can do to control this market.
Several specialist agents principally value pharmacies utilising a percentage of turnover as a guide and form of comparison. Less emphasis has historically been given to the underlying profitability of the business, which is an approach that we believe could be flawed, especially if the premises have inherently high occupational costs. We, therefore, primarily adopt a profits methodology for comparison and valuation purposes, with the multiplier used reflecting the perceived risk to the profitability, the apportionment of prescription sales undertaken (which are considered more secure) and the presentation, position, desirability and scope within the business being valued. Nevertheless, the turnover-related comparison approach is also taken into account.
Market Values for standard leasehold pharmacies are based on multiples of profit (assuming one fully involved owner-pharmacist and after having made an adjustment for a notional rent/actual passing rent) although, for larger turnover units, it is often more relevant to use a higher multiplier in order to assess performance and value on a fully managed basis.
In respect of integrated medical centre pharmacies, these are generally regarded as more valuable as there is a perception of less risk in handling the majority of scripts issued by the medical centre GP's than if the pharmacy was not within the same building. This is seen by agents as the area of the pharmacy market for which there is the greatest demand, particularly since the 100 hour exemption from the needs-based assessment of pharmacy contracts was removed in late 2012.
However, market sales' evidence is more difficult to secure, with many such operations held within corporate ownership and changing hands as part of group/Limited Company share transactions, if at all.
The pharmacy market is currently considered to be in growth stimulated by more certainty in the sector and an ageing population taking multiple medications. Values are considered to be relatively steady although transactional activity is at a higher level than most retail sectors and this is set to continue being fuelled by falling pharmacist salaries encouraging first time purchasing and easier funding. Nevertheless competition challenges continue with the advent of on-line services and distance selling contracts.
Experienced sector valuers such as Eddisons Taylors are again important to the Bank to ensure that appropriate comparable market transactions are obtained and that the evidence is correctly analysed. This includes the income being accurately extrapolated, especially where there is a wholesaling element. It is also important to understand the greater risk associated with practices operating with delivery and care home-reliant income.
The growth of both the dental and pharmacy sectors has also, to an extent, been based upon funding being available for leasehold-based practices because the serviceability levels have proven to be strong and purchasers are often either an incumbent associate or employed pharmacist where the ability to purchase has been reliant upon the vendor retaining the freehold interest. Whilst, therefore, the trade-related leasehold business interest might represent suitable security for loan purposes, the lease in question is likely to contain the normal forfeiture clauses in respect of non-payment of rent, breach of covenant etc., which aspect could detrimentally impact upon a lender's security position, particularly under default circumstances.
It is also important to ascertain if the lease is protected by the security of tenure provisions of The Landlord and Tenant Act 1954 (as amended), enabling a new lease to be obtained upon expiry of the existing. Otherwise, the value of the leasehold interest could be adversely affected, particularly as the lease termination date nears. Indeed, if the landlord is able to regain possession, there would be a need to find suitable premises, with an associated often expensive capital cost of refitting, together with some inevitable disturbance to the business.
An understanding of business tenancies and the ability to ascertain the level of market rent in respect of dentist (D1) and pharmacy (A1) premises is therefore vital and Eddisons Taylors have built up a significant level of knowledge in these respects. Indeed, we are able to discuss complicated leasehold arrangements directly with the Bank's solicitors to ensure that the Bank's security position is not reduced. We also have the knowledge and evidence to understand the 'specialist' influences on market rent that the location of a dentist or pharmacist within a medical/health centre can have.
For further guidance and/or information concerning the firm’s ‘nationwide’ Valuation and Appraisal services, in the first instance, please contact either Rob Bower MRICS on: 01604 662950 / firstname.lastname@example.org or Chris Mitchell MRICS on: 07720404776 / email@example.com