27-Mar-2010 Source: Conklin & de Decker
If you are one of the lucky/smart ones to be looking at acquiring an aircraft, you may be evaluating whether to lease or buy the aircraft outright (cash or a loan). If you are considering the lease option, evaluate it carefully.
In a lease, the owner (lessor) allows another the use of an aircraft for a fixed period of time. While leases come in many forms and versions, for this discussion, I will use an operating lease as my example. An operating lease is a lease whose term is short when compared to the useful life of the asset. For example, an aircraft which has an economic life of 30 years or more may be leased to a company for 5 years as an operating lease. This can be a simple leasing transaction where at the end of the lease, the aircraft is returned to the lessor. There may also be the option to buy the aircraft at Fair Market Value (FMV) at a set point during the lease and/or at the end of the lease itself.
One item to consider about an operating lease is that the residual value risk shifts the risk to the lessor.
In today’s aircraft market, values are lower than average, and there are a good selection of pre-owned aircraft to choose from. New aircraft manufacturers also have delivery positions available in the short term. Thus, the market favors the buyer. The aircraft portfolios of many aviation finance firms took huge hits in this recession. These financial institutions also may have repossessed aircraft that they need to get rid of. Pricing favors the buyer.
Given the current market which favors the buyer, why would you want to have the lessor accept the residual value risk now? Most aircraft values are likely to recover in the next few years. You, as the lessee, have a lower residual value risk than at any time in the last decade. Buying a good quality aircraft now leaves you with a minimal risk of the aircraft losing a substantial amount of its value in the future.
If you need an aircraft in the short term, maybe two years or less, look at a lease. Normally financial institutions tend to look with disfavor at short term leases. They don’t get to take the full tax advantages of the transaction and, for new aircraft, tend to see a significant drop in value over the first few years.
Today, the advantage to a lessor in a short term lease is twofold. First, they get rid of the aircraft as a liability and have some cash coming in. Financial institutions don’t like to have a lot of inventory in their name unless it is making a return. Second, if the market recovers in the next two years, the Fair Market Value will likely improve. Thus, the bank may recover a portion of the aircraft value at lease end, and be able to sell it much quicker than they can today.
Another item to consider about an operating lease is that leasing is better than financing if your company does not need the tax write-off from tax depreciation. Aircraft can be written off to zero value for tax purposes in eight or fewer years. You can’t use the tax write-off for a personal use aircraft.
If you are a company, leases may be “off balance sheet” as far as long term debt goes. If your company isn’t making a profit, tax depreciation is of reduced or no value anyhow. The lessee still can write off the lease payments as an expense, so both parties win.
However, the SEC and investors are getting savvier about “off balance sheet” deals. The balance sheet advantages of an operating lease can be mitigated by other factors. For example, people are reading footnotes or if the press sees a CEO stepping off an aircraft, it is news. Aircraft can be effective business tools, however you can’t “hide” the business aircraft as they are high profile.
As a final item, are you certain to need the aircraft for the full lease term? You can walk away from a lease at any time: just pay off the remaining lease payments. This can get quite costly. Read your lease terms carefully and do your homework to make as sure as possible that this is both the right aircraft and right lease length.
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. You need to examine your ownership, tax and risk requirements and review the lease documents with your aviation team to ensure your operations will not be constrained.
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