- 07 Sep 2023
- Gerrard Cowan
- Finance - BizAv
Cut through the misinformation about aircraft operating leases and discover who they benefit the most. Gerrard Cowan asks the industry about the common myths, and gains key tips on exploring if a lease is right for you...Back to Articles
Operating leases are a viable option for many private jet operators, particularly when it comes to budgeting. However, industry experts point to a range of common myths that surround the concept, both positive and negative, which could have an undue impact on a lessee’s decision-making. Following, we'll explore a few...
There are many types of leases, often with differing interpretations. However, at its most basic level, an operating lease is typically a ‘dry’ lease, meaning the lessee gains control of the aircraft for a defined period of time.
Within such an arrangement, the lessee does not own the aircraft, which remains the property of the lessor and is handed back at the end of the lease. Unlike a ‘wet’ lease, the lessee is in control of the flight and must supply their own pilot and crew members.
David M. Hernandez, Business Aviation and Regulation Sub-Practice Chair at Vedder Price, says it’s vital at the most basic level to understand what a lease actually is – notably whether it is a dry or a wet lease.
“People who are in the airplane – the passengers – might not realize that they’ve actually entered a legally-binding lease agreement and have responsibility for the insurance, the maintenance, and the pilots,” he says. “In a wet lease scenario, the lessor who operates the aircraft will be responsible for that.”
According to Ford von Weise, Head of Aircraft Finance at Citi Private Bank, and former President of the National Aircraft Finance Association (NAFA), the fundamental underlying precept of an operating lease is the transfer of risks associated with the future residual value of the aircraft.
This means that any increase or decrease in value will benefit or cost the lessor, not the lessee. There are clear benefits to this, as it means the lessee can budget for annual operating expenses and future costs of capital with far greater certainty than if the aircraft was owned outright.
“Corporate users with a need for budget predictability and no future surprises are the most frequent users of operating leases,” von Weise explains.
There are other potential benefits, he says, such as in terms of tax. Previously, an operating lease could be used to keep the aircraft off a company or individual’s balance sheet, but changes in US accounting rules have made this aspect less attractive.
There are clear advantages to operating leases in certain scenarios, but also numerous misconceptions, as follows...
The most common misconception about aircraft operating leases is that they are less expensive, which is frequently not the case, according to von Weise. “Often – especially in low interest rate environments – buying the aircraft outright may be cheaper,” he adds. “It is important to fully analyze the total costs of both ownership and leasing.”
For example, this could include the costs associated with maintenance, lease return costs, or opportunity costs for money invested in down payments. Importantly, all maintenance expenses and upgrades are at the expense of the lessee, he notes.
Another issue is that sometimes lessees assume they can simply return the aircraft at the end of the lease. The reality is that the aircraft can only be returned if the return conditions on the lease are satisfied, von Weise says.
Sometimes Business Aviation lessees do not fully understand or contemplate the potential for significant cash outlays when returning the aircraft, he warns. “Most operating lease agreements require a major inspection to be conducted – at the lessee’s expense – at the end of the lease term.
“These major event inspections can be costly, unpredictable and time consuming. The lessor will also require its own inspection and may charge steep fees for any cosmetic blemish. The costs associated with the combination of these two inspections can be very high – often exceeding a million dollars.”
Terminating a lease early can also be very expensive. While lessors often will include one or two early termination provisions during the term, any attempt to terminate a lease at any other time can be very costly.
And, von Weise says that aviation regulatory requirements can often necessitate significant cash outlays that benefit the owner, not the lessee. For example, regulators may impose equipment update mandates on aircraft operators. Even though the lessee does not own the aircraft, they will still have to pay for the upgrades if the mandate was issued during the lease term.
There are many potential upsides of operating leases that are often be overlooked, too. Simon Davies, Vice President of Sales – UK, Middle East and India – at Global Jet Capital, says that many operators neglect to consider that operating leases can be much more capital efficient, even if some may automatically consider it a bad deal that they do not own the aircraft.
“With a cash purchase or a loan requiring a significant down payment, considerable capital is being deployed in what would be considered by many as a ‘non-core’ asset,” Davies elaborates.
“This capital contribution, arguably, would be better deployed in assets or investments in the business that could appreciate and deliver better overall value to the company or the individual.”
Another myth is that operating leases can be restrictive, and that it is better to own the asset, said Davies. However, an operating lease can enable operators to enjoy the experience of full ownership, including customizing the aircraft to their liking, provided it falls within ‘normal patterns’ of ownership and does not present a clear and obvious negative impact on residual value.
“An operating lease on a business jet – no different than with a car – provides the client with a complete ownership experience,” Davies explains.
“With the right lessor, you can expect contract terms that fit your specific needs, which makes the experience of having an operating lease feel anything but restrictive.”
Wendy Preston, Head of Asset Management at PNC Aviation Finance, also points to the misconception that aircraft leases can be too restrictive. If a lessee is upfront with the lessor on how they plan to operate the aircraft – in terms of numbers of hours, maintenance programs, Part 135 charter use, and so on – the lease can be structured so that there are few, if any restrictions on aircraft operations, she adds.
Preston stresses the importance for lessees to communicate, up front, with potential lessors on how they plan to operate the aircraft. Failure to do so is likely to see the lessor make assumptions about that use when factoring in residual value, which impacts the leasing payments.
“For instance, if a lessee communicates that they plan on flying 600 hours per year, the lessor will likely lower their residual value to account for a high usage aircraft, thus giving the lessee a higher payment,” Preston says. “However, if the lessee ends up flying only 300 hours per year, they end up paying for hours they did not put on the aircraft.”
Turning to other potential misunderstandings, Davies says there could be a belief that operating leases only make sense in bad resale markets, not when resale values are strong.
But even if there is a robust pre-owned aircraft market when you choose to acquire an aircraft, that may not be true in perhaps five to seven years when it is time for an upgrade. “No one has a crystal ball when it comes to predicting markets,” Davies argues.
“An Operating Lease actually provides the client with peace of mind regarding residual value risk, minimum down payments, predictable costs, and disposition certitude at the end of the lease (or sooner, if necessary).”
Finally, Davies points to privacy as another potential concern from would-be aircraft operating lessees. Global Jet Capital has encountered buyers who were under the impression that privacy can only be achieved by buying an aircraft, he shares.
“If privacy is important to a buyer, a leased aircraft may in fact provide an additional layer of anonymity,” he highlights. “An operating lease reduces visibility to an aircraft’s end-user, as the public records of the FAA identify the lessor as the owner of the aircraft, giving you greater privacy.”
Joanne M. Barbera, Founding Partner of Barbera & Watkins, LLC, reiterates the importance for operators to fully understand the type of lease they are getting when they opt for an operating lease.
Second, she says they must be totally clear on their responsibilities with respect to the aircraft for the term of the lease, including the hours it can be used, the areas of the world it may travel, operating requirements, maintenance demands, and more. Some of these may not be obvious.
“If I am the lessee, I am responsible for making sure that aircraft is airworthy and that it is operated legally,” she illustrates. This means ensuring you hire qualified pilots who meet insurance requirements and the demands of the FAA or other relevant body.
Even then, the operator may not be sophisticated in terms of flying, so may need to hire professionals – such as aircraft management personnel – to check the aircraft before flight. The lessee is responsible for ensuring that all these professionals have the expertise and opportunity to perform these tasks on their behalf.
“As the operator – as the person responsible for the safety of that flight – I have responsibility for whatever happens on that flight,” Barbera emphasizes. “If there is an aviation regulatory violation, somebody is hurt, or something is damaged, that's generally a lessee’s responsibility.
“Also, I need to clarify in my lease which party provides the insurance, and that I'm satisfied with the level of insurance and the details of my coverage. That will be important in a liability or damage situation,” she adds.
According to Adam Meredith, President of AOPA Aviation Finance, as with any contract there is usually room for negotiation, and typically more to negotiate on a lease than a straight purchase. Lessees should ensure they’ve “hired good, competent experts to review the documentation and inform you of exactly what you’re getting into.”
But Meredith’s main advice is to “choose a good plane, meaning one where there’s a decent possibility of its actual residual value outperforming the agreed upon tables.”
Discounted cash flow analysis should be prepared for both aircraft ownership and leasing scenarios to compare all costs between leasing and ownership, Von Weise suggests. This should include all annual variable operating costs, such as fuel.
Leasing can certainly be very beneficial to aircraft operators who understand all the costs, and who carefully plan and understand their future aircraft utilization, he adds.
It will benefit those who do not have a tax liability themselves, desire budget certainty, are willing to give up on any future residual upside in value and know that they will not need to terminate the lease early, he summarizes. “Such operators will not want to strand any equity in a non-income producing asset, and know how long they want to utilize the specific aircraft.”
Ultimately, as Davies concludes, every buyer is different, and understanding their specific requirements is essential to achieving a winning value proposition.
“Anyone looking to finance an aircraft should talk to two or three sources to understand their options, their requirements, along with each institution’s strengths, which can be different,” he says.
“They should make sure to include at least a couple of specialized financiers that can work with their specific situation.”
More information from:
AOPA Aviation Finance: https://finance.aopa.org
Barbera & Watkins, LLC: https://bwaerolaw.com
Citi Private Bank: www.privatebank.citibank.com
Global Jet Capital: www.globaljetcapital.com
PNC Aviation Finance: www.pnc.com
Vedder Price: www.vedderprice.com
Read more about Aircraft Leases in the AvBuyer Finance Article Archive