- 22 Sep 2021
- Gerrard Cowan
- Finance - BizAv
Who do aircraft leases benefit the most, what length of lease is usual, and what rate can you expect to pay? David Wyndham explores answers to these, and other FAQs.Back to Articles
The business jet is an asset: It is an item of value that is controlled by you and your aviation department. Ultimately, its value is a function of how well the aircraft is managed in the areas of utilization, maintenance, and financing.
Following, we will focus on the financing of the aircraft via an operating lease, which offers the lessee a specific period of aircraft access with a defined, fixed cost of ownership in the form of a lease rate. The financial institution (lessor) ultimately retains ownership, and, as such, assumes the residual value risk and enjoys the tax depreciation benefits.
In evaluating a lease, versus a finance or cash purchase, the analysis of the costs involves the ‘ownership cost’. The ownership cost of an aircraft is the total of:
Whoever the owner of the aircraft is assumes the residual value risk/reward. With a cash purchase, the owner(s) have 100% of the risk. With financing, the final owner and financing entity share the risk until the debt is paid off. With an operating lease, the leasing entity is the owner who retains the residual value risk.
Thus, with a lease the ownership cost is fixed to the lessee in the form of the total amount of the lease payments.
What is the Usual Length of an Aircraft Lease?
Lease lengths vary, and are fixed in length. The lessor typically looks for a long enough term that they can take full advantage of the tax depreciation benefits. Some lessors offer short-term leases, running as short as 18-24 months. This is particularly useful to operators waiting for the delivery of a factory-new aircraft as they can lease a pre-owned aircraft for their exclusive use.
Given the short lease length, the rates are typically higher since the lessor must take back the aircraft and either sell it, or lease it to a new lessor after a relatively short period.
Long-term leases vary in length. For turboprops and jets, a long-term lease typically ranges between seven and 10 years. (Some piston aircraft manufacturers may coordinate with financial institutions to have leases for their new models of up to 15 years or more.)
What is the Usual Rate of an Aircraft Lease?
Lessors will always seek to protect the financial downside. Since they carry the risk of the aircraft’s residual value, retaining ownership at the end of the lease term, the lessor will price the lease rate accordingly, covering that risk.
Several experts within the industry estimate a 10% annual decline in the value of turbine airplanes. Lease rates reflect the uncertainty in an aircraft’s future values, and rates are also connected to the popularity of the aircraft, while being tied in to the cost to the lessor of borrowing.
Would-be lessees should be aware that leases come with end-of-term condition requirements. There will be adjustments for high utilization, since this impacts the maintenance status of major components, and reduces the residual value of the aircraft.
Many lessors will also require the engines to be enrolled on a guaranteed hourly maintenance program, since engine maintenance is a major cost driver in operating costs.
Can You Exit an Aircraft Lease Early?
If you want to exit an aircraft lease prior to its contracted end, you can always pay the remaining lease payments, but this is very costly. You may want to look for an Early Buy-Out (EBO) option, allowing the lessee the option to exit the lease by purchasing the aircraft. As an example, on an eight-year lease, you may have an EBO at years four, five, and six.
The financial institution will offer the EBO at a fixed-price that covers its conservatively estimated residual value, and as a result the EBO may be greater than the fair market value at the buy-out time.
Tax Depreciation and Aircraft Leases
The lessor retains the tax depreciation benefits. Lease payments may be tax deductible when the leased aircraft is used primarily for business. If you don’t want to, or cannot use, the tax depreciation on an aircraft, a lease may be a better option compared to whole ownership.
Always check with a qualified aviation tax advisor regarding this.
Who Benefits Most from Aircraft Leases?
So, ultimately, what type of Business Aviation user would benefit the most from leasing an aircraft? You should consider the benefits offered by an aircraft lease if, a) have a fixed period for which you wish to have the aircraft; b) have no need of tax depreciation; and/or c) have average or lower-than-average annual utilization.