- 28 Jul 2021
- Fabrizio Poli
René Armas Maes asks, what are some of the ways that an owner or operator can minimize their residual value concerns?Back to Articles
Previously, René Armas Maes discussed how business aircraft buyers can save money and optimize their operations, whilst considering the hidden cost of an aircraft’s residual value. But what are some of the ways that an owner or operator can minimize their residual value anxiety?
Aircraft residual values depend on many factors, including general economic conditions; an aircraft’s make and model; and the condition of the pre-owned aircraft market at the time of the sale, among other things.
Market downturns inevitably weaken aircraft residual values, negatively impacting the cost of aircraft ownership. Certain aircraft types, models and cabin segments are more impacted than others. For example, when it comes to residual values, historically speaking the Very Light and Light Jet sectors have been hit harder than others.
Following, we will consider ways for potential aircraft owners to limit anxiety regarding business aircraft residual value, whether they’re planning the purchase of a fractional share, or they’re taking ownership of a factory-new aircraft.
A Wide-Spread Concern
Residual value anxieties are a real concern not only for buyers of factory-new aircraft and fractional share owners, but also of pre-owned jets for sale and the business aircraft Original Equipment Manufacturers (OEMs) themselves.
CHART A: How OEMs Build Provisions to Minimize the Impact
of Certain Sales Incentives
On the one hand, aircraft owners or fractional share buyers want to protect their investment and reduce the cost of ownership when factoring in the amount they will receive when the time comes to sell their asset or dispose of their share.
On the other hand, OEMs want to limit the residual value impact over time, especially as this enables them to firm-up prices for their brand-new aircraft portfolios.
One way for the OEMs to protect themselves is to seek insurance or collateral, covering unforeseen asset value losses when negotiating financing and sales guarantees with customers.
Residual Value Guarantees (RVGs)
RVGs are nothing new in the commercial airline world including for regional aircraft and turboprop aircraft used by scheduled airlines, and are typically structured for a time period of 10 to 15 years.
In Business Aviation, the time period is usually five to eight years. As an example, a scheduled airliner OEM may offer a RVG for a new aircraft, and provide the aircraft owner with a predetermined amount when it decides to sell the asset when the aircraft’s residual market value is lower than originally forecast.
As a matter of fact, Business Aviation OEMs may offer several sales incentives, and financing support guarantees to help enhance the ability of certain customers to arrange third-party financing for their acquisitions and to expedite sales, including credit guarantees, trade-in options, lease subsidies (where applicable) and Residual Value Guarantees.
Indeed, extra OEM flexibility and stronger buyer negotiating power can be expected more for large, multi-aircraft orders than for a single aircraft order, unless the latter is viewed by the OEM as a strategic sale or customer, or sometimes on products such as Ultra-Long-Range jets.
The rationale from an OEM’s point of view is simple: Those incentives are instruments to help smooth the way for key deals. But the risks to the OEM increase in terms of potential market exposure, with liabilities that could end up reducing profits and margins.
Negotiating a Favorable RVG
A typical RVG in Business Aviation will be offered upon the expiry of certain financing agreements, which provide a contractual limited payment to the guaranteed party under certain negotiated terms and conditions.
OEMs treat RVG negotiations as confidential which are executed on a one-to-one basis for a specific aircraft order, operator, and aircraft type/model, for example, in a set timeline. For buyers to strengthen their negotiating power, they need to investigate:
Fractional Ownership & Fair Market Value…
On the other hand, and when considering buying a fractional share, fractional ownership programs guarantee a share buy-back option, based on an estimated Fair Market Value (FMV) upon the expiration of the contract (typically a 5-year period).
But from a fractional owner’s perspective, the key question is “what constitutes an aircraft’s FMV at the end of the contract?” To avoid future disputes, potential share buyers need to understand how this will be calculated.
While it is true that fractional share owners bear the risk of the residual value at the end of the program, like whole aircraft owners do, it is important to understand that fractional ownership aircraft are typically flown between 800 to 1,200 hours annually (compared to 250 to 400 hours annually for a wholly-owned aircraft).
A fractional plane will accumulate more hours, cycles and equipment wear and tear than an average Part 91 aircraft. Overall higher aircraft utilization and typically six-to-eight shared owners per aircraft will penalize the initial share price. Therefore, share owners can expect lower-than-average residual values.
As an example, as advertised by Jet It (a fractional ownership provider which operates a fleet of HondaJets), 44% of the initial share value is guaranteed at the end of the share-owner’s contract.
However, many fractional ownership programs offer the chance to opt out of the program before the end of the agreed term (for a penalty fee), and still offer guaranteed residual values. For instance, and again in the case of Jet It, if a share owner exercises the option to leave at the end of Year 3, it is guaranteed 50% of the initial share value, while at the end of Year 4 the amount is 46%.
If you are considering buying a fractional share, first investigate and understand:
Chart B shows a number of initiatives that can be used to help minimize the “residual value anxiety” both from a brand-new aircraft owners, and fractional share purchasers.
CHART B: Strategies for Negotiating Better Residual Value Clauses
In my opinion, residual value anxieties may play a more important role when buying a fractional share than for a brand-new aircraft purchase – especially if your contract ends during a market downturn. But even then, there are potential solutions if you still have the need to travel.
This could include choosing to extend your share contract for another two to three years, with a view to capitalizing on a stronger economy and stronger residual value.
To completely avoid the residual value conversation with potential owner, Business Aviation providers may choose to implement other strategies and business models.
One example would be where a number of flight hours are offered with no buy-back component (such as for a jet card product, or an operating lease by which neither a share nor asset depreciation is applicable from a user point of view).
Finally, it is wise to agree on a third-party appraisal, especially when the difference between the owner’s and the guarantor’s chosen appraisers is significant.
Essentially, reducing residual value anxiety requires knowledge of the pre-owned market; the ability to manipulate key market intelligence and technical data; and a clear understanding of the RVG terms and conditions negotiated in the first place. Doing your homework before agreeing and signing any contract is key.