| FLEXJET Fractional Jet News Briefs (Courtesy of NetJets, "The Buyer's Guide to Fractional Aircraft Ownership") |
While the bottom line is that fractional aircraft ownership allows people to enjoy the benefits of private aviation at a fraction of the cost of whole ownership, this is still a substantial investment over many years. And, there are real differences in the pricing and the economic terms and conditions of the major providers. Therefore, you will want to be informed on all of the factors that will affect your total cost of ownership.
Acquisition Costs
Evaluating the first-time acquisition costs of a fractional program’s aircraft would appear to be a straightforward proposition. If you purchase a 1/8 share in an aircraft, you would expect the price listed by the program for that share to be 1/8 of the fair market value for the entire aircraft, and this is often the case. However, depending upon the fractional program you are considering, the aggregate price for the fractional shares of a particular aircraft may be well above fair market value for the entire aircraft.
The importance of paying fair market value
Whether you purchase a new or used interest, you should not be paying a premium for this interest for the privilege of joining a fractional program. You won’t recover that premium when it comes time to resell – unless, of course, you can find someone willing to pay more than the asset is actually worth.
Chances are you will want to sell your plane back well before the end of its useful life. Perhaps to upgrade to a larger plane. Perhaps to change programs. You will want to know that you can recoup a high percentage of your original purchase price. If you bought a share for a purchase price above fair market value, you will experience a substantial economic penalty when you sell. Remember, the fractional provider is agreeing to buy back your share at the fair market value at the time you elect or are required to sell.
You will often find that the purchase prices asked for shares in both new and used jets are significantly above the fair market value for those aircraft.
Acquisition costs of pre-owned aircraft
With fractional programs that sell shares in pre-owned aircraft, determining the appropriate purchase price can be complex. A number of factors determine the value of a pre-owned aircraft, including:
Age Age evaluation includes hours flown, number of landings, date of manufacture, etc. This may seem obvious, but a 10, 15, 20-year-old aircraft will not command the same price on the open market that a 5-year-old aircraft will. As airplanes age, the cost of maintaining them increases, especially after initial warranties expire on the airframe, engines, and avionics.
Complete maintenance history Everything that has ever been done to an aircraft is supposed to be recorded in detail in its logbooks. If there are gaps in an aircraft’s maintenance history, its value decreases.
Who has done the maintenance? A pre-owned aircraft that has been maintained solely by its manufacturer or authorized service center commands a higher price that one that has been cared for by other providers of maintenance services. If a pre-owned aircraft has not been exclusively factory-serviced, then it should have been cared for in top-tier, manufacturer-authorized service centers.
Features Newer models of an aircraft often have advanced technology features that make them more valuable. Rapid advances in aviation technology affect radar, navigation equipment, flight management systems, and safety systems. So, to keep older aircraft safely up-to-date, it is necessary to continually invest tens or even hundreds of thousands of additional dollars every few years.
Previous addresses It’s also important to know where a plane has been hangared. Aircraft that have resided in certain geographic areas are worth less on the open market than those that have been hangared and maintained in the U.S. and Europe.
While the process of determining the true value of a pre-owned aircraft can be a trick one, there are publications such as Aircraft Bluebook – Price Digest, Residual value guide, and Vref – Aircraft Value Reference that give estimates of an aircrafts’ "blue book" value. Since a particular serial-numbered aircraft’s resale value can be affected by many factors including current supply and demand and recent comparable sales, these blue-book values may only be approximations. If you are considering purchasing a share in a used aircraft, get a professional consultant to appraise the specific serial-numbered aircraft. You will find an appraisal is not expensive and well worth the investment.
Mandatory sell-back/repurchase requirements – how they affect the economics
How long do you plan to fly privately as a fractional owner? Most fractional owners find the notion of going back to other forms of air travel extremely unpalatable, and they want to continue flying privately, forever.
All fractional ownership companies require you to purchase an aircraft share and sign an initial management agreement of 5 years. However, some programs also require you to sell back you share after 5 years and purchase another if you want to continue flying. If you remain a fractional owner beyond that initial five-year period, as most do, this will have an impact on your long-term costs of ownership.
There are three negative financial consequences from a contract requiring repurchase after five years:
If you choose to remain a fractional owner, you will have to pay the acquisition cost associated with purchasing a new share, perhaps in the same aircraft type you have just sold, at a premium 15-20% higher than you paid five years earlier.
2. If the price you paid was above the fair market value at the time of purchase, the amount you will get back when you sell your original share, could be considerably less than your original purchase price
You will loose the markup plus any normal decline in value of that
aircraft during the five years.
Finally, used aircraft values fluctuate. The end of your five year period may coincide with a time when the demand for used aircraft is "soft" and you will not be able to delay your sale to get a better price.
The financial impact of a repurchase requirement will increase with (a) the rate of increase in the purchase price per year of a new aircraft, (b) the cost of capital as it relates to the size of your initial investment, and (c) the length of time you own a share. Your costs will increase and you could still be flying in the same fleet and, perhaps, in the same aircraft you just sold back to the provider.
If you are planning on flying privately more than five years, the economics favor a provider that does not require you to sell the asset back after five years.
Evaluating the total cost of ownership
You can consider all of the factors involved in the purchase of a fractional aircraft interest utilizing a simple cash flow model. To do this, prepare a financial spreadsheet that incorporates every inflow and outflow of cash over the entire period you won your fractional interest.
The cash flow approach allows you to calculate the total costs of ownership for a particular share as well as the cost per flight-hour. You can even create two or more spreadsheets and compare the total costs for aircraft and fractional programs with very different cost characteristics.
In the most basic model, one not including your own tax considerations, the key cost components to include are:
The purchase price The initial outlay for the aircraft share.
The occupied hourly cost per year The occupied hourly fee for the fractional share multiplied by the number of flight-hours per year.
The monthly management fee The annual fixed expenses (i.e. pilot salaries, pilot training, insurance, and administrative support) for your aircraft share.
Cost of capital The purchase price for your aircraft or share multiplied by the rate of return you would expect to earn. Whether you invest in an entire aircraft or a fractional share, you lose the chance to earn interest on that money.
Federal excise tax Currently 7.5% paid on the occupied hourly fees only.
Residual value This is the only inflow of cash in this basic model. It is the amount of money you would expect to recoup on your initial aircraft investment if you sold it back at the end of the contractual period at the fair market value. Again, if you overpaid at the time of purchase, you cannot expect to get that markup back when you sell your interest.
The cash flow allows you to consider all factors at once. Some programs may look the same on the surface, with similar aircraft prices, monthly management fees, and occupied hourly fees. However, one program’s aircraft may be priced above fair market value or have a mandatory repurchase requirement. Each of these factors may make their long term, total cost of ownership higher, especially if you look at it over six or more years.
Alternatively, a fractional program may offer shares in old aircraft at acquisition prices that are substantially lower than what other programs are asking for new shares. Yet, when you factor in the markup on the used aircraft and the loss you will experience when you sell back your share at fair market value, you may find that you can purchase a brand new aircraft share for nearly the same total cost.
An illustration – new vs. used aircraft
As an illustration of this point, the impact of paying above fair market value, let’s consider the costs for the airplane itself, ignoring the monthly and hourly fees, which are similar enough in the example we have chosen.
Your can purchase a 1/8 share in a new Citation X for approximately $2.26 million dollars. Conservatively, assume it retains 80% of its value after five years such that you recoup $1.8 million dollars if you sell at that time. Your total cost for the aircraft itself will be the difference of $452,000 plus the cost of capital of $2.26 million dollars at 7% or $791,000 (over five years without compounding) for a total cost of $1,243,000.
Compare this to a 20-year old 1983 Falcon 50 in which you can by a 1/8 interest for $1,600,000. The purchase price is nearly 30% lower. The fair market value for 1/8 of the Falcon is $1,250,000, significantly below the purchase price being asked for it by the fractional ownership company. Assume this airplane also retaining 80% of its fair market value after five years such that you can recoup $1,000,000. Your expenses will be the difference between the purchase price and the residual value, or $593,000 plus the cost of capital on the $1,600,000 investment at 7% or $560,000. Thus the total cost would be $1,153,500.
In summary, while the purchase price for the Falcon is nearly 30% below that for the new Citation, when you factor in the markup on the Falcon and the loss you will experience when you sell back your share at fair market value, the total cost is only 7% below the Citation.