Maximize real estate when selling your dental practice to a DSO

Selling a dental practice to a dental service organization (DSO) can be a financially and personally rewarding opportunity. For dentists who own the practice real estate, it’s vitally important to understand how to properly manage the practice sale transaction terms to maintain real estate flexibility and value. A few common mistakes many real estate owners make can reduce value or make the real estate unsellable to well-capitalized investors until the lease terms can be corrected, which may not be possible until the end of the multiyear lease term.

There are some time-tested real estate strategies for selling to a DSO or any other seller. These strategies will help maximize the overall value of the dental practice and its associated real estate. This is based on many decades of experience as a practice owner, commercial real estate investor, executive of a large DSO, and someone who has an MBA from Cornell with a focus on real estate finance.

How DSOs view the real estate

DSOs value a dental office based on the clinical and administrative team, operational systems, quality of care, patient base, brand recognition, and income-generating capacity. Most DSOs have a mandate from investors, private equity, and bank covenants that focus on using their capital to grow revenue and profit, not invest in real estate. As a result, it’s extremely rare that a DSO will purchase the real estate of a dental practice. 

However, DSOs place a significant amount of importance on the practice's real estate capacity, quality, and lease because they need to ensure that the practice will be able to continue operating in the same location for an extended period. If the practice needs to be relocated there will be expenses and potentially significant patient loss.

Tenants, DSOs included, want to strike a balance between long-term security and flexibility. One way to accomplish this is with a shorter initial term and multiple tenant extension options thereafter. Landlords, however, want to seek as long of a guaranteed initial lease period as possible. This is because any time beyond the initial lease term is not guaranteed, limiting potential cashflows to the landlord and thus the value of the property. 

The sale leaseback

In a typical real estate transaction, property owners sell the building and move out so the new owner can use the space for their needs. However, in a sale leaseback, the objective is to sell the building and remain as a long-term tenant. The sale leaseback enables the property owner to sell the real estate and receive cash at closing while allowing the practice to continue operating as a tenant under a long-term lease.

Many hospitals and physician practices build their facility with the intention to then immediately execute a sale leaseback upon completing construction to offset their construction costs. According to SLB Advisor Annual Report, there were $16.9B sales leaseback transaction in 2023 with $1.4B of them in medical real estate.¹

Selling the building before you sell the practice 

Formerly, when most dental practices were purchased by individual buyers, a widely held belief was that it was best to own both the practice and the real estate. But these days the most frequent buyers of dental practices are DSOs that do not buy real estate. To avoid getting stuck with the property after the practice sale, sell the real estate before selling the practice. By doing this, real estate owners are able to complete the real estate sale and lock in fair market lease terms that will not interfere with their practice sale while maximizing the value of the real estate.

If the real estate transaction occurs after the practice has been sold to a DSO, the new real estate investor will need to assume the lease that was entered into with the DSO when they acquired the dental practice. Speaking from experience, real estate is one of the last items handled during a practice acquisition. This is because the majority of practice sellers do not own the real estate, and they don’t want to notify their landlord of the sale until the deal is nearly completed. This means that leases are frequently handled when deal fatigue is setting in, the most ideal terms for the real estate owner are not established, and the dentist real estate owner suffers. 

The gold standard for a successful sale leaseback transaction

To maximize the dental real estate value, ensure that the lease terms meet a well-known criteria that make it attractive to potential buyers. Including these three gold standard terms for commercial real estate in your lease will help you achieve the best price for your real estate, typically with no adverse impact on your practice sale transaction price. 

1. The triple net lease (NNN): The most common lease structure for commercial real estate is triple net lease (NNN). Most professional real estate operators will not buy a building with an alternative lease structure, such as a gross lease. In a gross lease, the tenant pays a fixed rent amount, and the landlord is responsible for all property related expenses. Under the NNN, the tenant is responsible for the base rent plus the exact amount of the property’s actual expenses: property taxes, insurance, and maintenance costs. 

A professional real estate investor and most banks require this structure because it provides a stable cash flow and maximum transparency. On the other hand, the gross lease provides a variable cash flow due to the variable nature of building expenses, such as snow removal. (Some years are snowier than others.) 

The base rent in a NNN is much lower than the rent in a gross lease because the actual exact expenses are paid by the tenant. Most tenants prefer this format because of the transparency of paying exact expenses. Alternatively, in a gross lease there will be a significant buffer added to expenses for the landlord to be sure the overall rent is not unprofitable. As professional business operators, DSOs understand that professional landlords require NNNs, and this structure does not adversely impact practice valuations and transactions

2. Extended initial lease term and options: The initial lease term is an extremely important component to get right. Fortunately, dentists, real estate investors, and DSOs think alike and typically prefer long-term leases. Real estate investors need tenant stability, dental practices need location stability, and DSOs want to know their investment has a location secured for many years to come.

The gold standard term for commercial real estate is 15 to 20 years. However, 10 years is most common with DSOs. If planning to sell the real estate a few years after selling the practice, be sure to include enough duration in the lease to account for the gap years between the lease and sale. A professional real estate investor either won’t buy when the lease has only a handful of years remaining, or will seek to pay a lower price for real estate to account for a tenant that can leave in just a few years.

An option in a lease gives the tenant the choice to extend their lease after the initial term expires for a pre-agreed rental rate. Typical options are five to 10 years and leases frequently contain multiple options that allow tenants to have control and a pre-agreed rent for decades. This is a very effective tool to ensure the dental practice can remain in the same location for years. 

3. Setting the right rental rate: A common operational expense benchmark in the dental industry is to target a rent expense of 5% or less of practice revenue, new de novo start-ups excluded. Frequently, practice operators may have an incentive to set the rental rate higher than the market rate or 5% of practice revenue, however this is likely to make a real estate investor and DSO practice buyer uncomfortable. 

A professional real estate investor will look for a rental rate that is in line with the fair market rent of the area and will seek annual rent increases of 2.5% to 3.0% per year. Fair market, competitive rates are sustainable for both the tenant and landlord and are the gold standard for M&A professionals. 

The purchase price of the building can be determined using a combination of two methods: third party appraisal of the land, and structure and a capitalization rate formula. The capitalization rate is the rental income divided by a percent (typically 6%–10%) that represents the yield or return an investor would expect for that asset class in a particular regional market. Example: $75,000 (rental income) ÷ 8% (cap rate for retail space in a market) = $937,500 building value. A lease rate that reflects the local market demonstrates that the property is a sound, sustainable investment.

Conclusion

Selling a dental practice to a DSO presents a significant opportunity, and preparing both the practice and the real estate to maximize their value is essential. To increase the real estate’s value to potential buyers, ensure that the lease structure adheres to commercial gold standards. It can be advantageous to sell the real estate before selling the practice.

Rest assured that a reasonable lease that conforms to these standards will neither interfere nor diminish the value of the practice sale. On the other hand, a lease that does not conform to these market standards will likely radically diminish the value of the real estate, and once the practice is sold, the new owner and tenant will not want any lease changes until the end of the agreed upon term, which could be decades.

Editor's note: This article appeared in the May 2025 print edition of Dental Economics magazine. Dentists in North America are eligible for a complimentary print subscription. Sign up here.

Reference

1. SLB sale leaseback market update March 2024. SLB Capital Advisors. https://mpfs.io/assets/slb/24/03/SLB-Market-Update-March-2024_vF-98c19a4e-9ff3-4d85-af02-59312a777d03.pdf