Based on the current market environment, this could be the perfect time for companies and individuals to consider a business aircraft acquisition. Often the question, however, is not, “if I should acquire,” but rather, “How?”
There are two basic routes: You can buy an aircraft outright with cash or a loan, or you could lease one, which offers a “walk-away-with-no-further-obligation” advantage at the end of the lease. Each method has benefits as well as potential disincentives so it is important to consider all of the factors.
Leases come in many forms. Operating leases are the most common. In a lease, the owner (the lessor) provides you (the lessee) with use of the aircraft for a fixed period of time. Operating lease periods are typically short in comparison to the useful life of the asset, so for example, an aircraft with an economic life of 30 years or more might be leased for five years. This can be a simple transaction where at the end of the lease, the aircraft is returned to the lessor or there might be an option to buy the aircraft at fair market value at a defined point during or immediately after the lease term.
In an operating lease, residual value risk shifts to the lessor protecting the lessee from loss of market value.
Shifting market risk is a good thing for the lessee particularly during periods of economic uncertainty or when values are very high and a downward trend is predicted. In today's aircraft market, however, values are below average due, in part, to the large quantities of quality pre-owned aircraft available. Aircraft portfolios of many aviation finance firms took huge hits in this recession and these financial institutions have aircraft that they need to sell. In addition, new aircraft manufacturers have delivery positions available in the short term. Thus, today’s market clearly favors the buyer.
Given the current market, which is forecast to remain stable or improve, is it better to accept the residual value or shift that risk to the lessor?
Most aircraft values are likely to recover in the next few years. Therefore, buying a good quality aircraft today leaves one with a minimal risk of future value decline. In fact, as an outright buyer, your residual value risk is lower than at any time in the last decade.
If your aircraft acquisition plan is short term, perhaps two years or less, a lease may be an attractive alternative.
Normally, financial institutions tend to view short term leases unfavorably because they aren’t able to take the full tax advantages of the transaction. Also, with new aircraft, there’s a tendency to experience a significant drop in value over the first few years. In the current market, however, lessors may see advantages in short term leases for aircraft they have on their books. First, they eliminate that aircraft as a liability by generating a positive lease payment cash flow. Second, if the market strengthens over the short-term lease period, the financial institution can recover a greater portion of the aircraft value when it is sold eventually. It’s a win/win situation because the lessor gains rental revenue while waiting for an improved market opportunity.
Leasing is better than financing if your company doesn’t need the depreciation or tax write-off.
Tax write-offs are unavailable for personal use of an aircraft. In this case, it could be beneficial to transfer the tax advantages to a leasing company, which results, typically, in lower lease payments.
While a corporation acquiring a business aircraft outright does gain tax benefits by depreciating the asset to zero value in eight or fewer years, there are cases where depreciation has reduced or little tax benefit. In those situations, leasing makes a great deal of sense. The tax advantages transfer to the lessor, the lessee keeps the acquisition off the balance sheet without diluting key financial ratios and the lease payments become a lessee operating expense, which does offer a tax benefit. It is important to note, however, that these "off balance sheet" deals may incur scrutiny by investors and the SEC. While most companies view a business aircraft as an invaluable business tool, the general public often lacks that perspective. Annual report footnotes may prompt uncomfortable questions or if the press observes a CEO stepping off an aircraft, it can become big news.
A lease may be a great solution, but do you need the aircraft for the full lease term?
Consider the lease terms carefully to make certain that both the lease and the aircraft will fit your needs throughout the length of the lease period. Market projections, company growth forecasts and capital expansion plans can have a significant impact on desired lease provisions as well as aircraft choice.
I wrote earlier in 2009 that cash is king in the aircraft transaction. That is still true. You will get the best deal and the quickest closing in a cash transaction. Leases can work for some companies and individuals, but you need to cautiously examine your ownership, tax and risk inclinations in addition to reviewing the lease terms with experts in financial, tax, and technical aspects of business aircraft operations.