Following on from his December article, ‘How to Understand the Scrap Value of a Jet’, aircraft appraisals expert Jeremy Cox continues his discussion. Is there a sweet-spot to part an aircraft out earlier than is normally considered the last-ditch operation?
All business jets have cycle-limited components. Few have an actual airframe limit imposed upon them. With fatigue testing, OEMs predict that few (if any) of their aircraft will accumulate enough flights/cycles prior to retirement to reach a point where structural damage occurs.
As an example, Dassault has the Supplemental Structural Inspection Program (SSIP) for the Falcon 20 series, requiring an aircraft reaching either 20,000 flights or 30,000 hours to undergo an in-depth structural Non-Destructive Testing (NDT) program prior to it being allowed to continue in service.
To my knowledge, excepting a handful of freighter-converted Falcon 20s no corporate-use Falcon 20 has triggered the need for an SSIP.
In fact, the average cycles for the entire worldwide fleet of business jets is currently below 5,000. So, if physical deterioration isn’t a key factor in an aircraft reaching the end of its useful life, what is?
The Three Forms of Depreciation
When operating as a certified aircraft appraiser, I am required to consider three forms of depreciation, including:
- Physical Deterioration
- Functional Obsolescence
- Economic Obsolescence.
The American Society of Appraisers manual ‘Valuing Machinery and Equipment’ (third edition) provides the following definitions…
Physical Deterioration is a form of depreciation where loss in value or usefulness of a property is due to the using up or expiration of its useful life caused by wear and tear, deterioration, exposure to various elements, physical stresses, and similar factors.
Functional Obsolescence is a form of depreciation in which the loss in value or usefulness of a property is caused by inefficiencies or inadequacies of the property itself, when compared to a more efficient or less costly replacement property that new technology has developed. Symptoms suggesting the presence of functional obsolescence are excess operating cost, excess construction (excess capital cost), over-capacity, inadequacy, lack of utility, or similar conditions.
Economic Obsolescence (sometimes called ‘external obsolescence’) is a form of depreciation where the loss in value of a property is caused by factors external to the property.
These may include such things as the economics of the industry; availability of financing; loss of material and/or labor sources; passage of new legislation; changes in ordinances; increased cost of raw materials, labor, or utilities (without an offsetting increase in product price); reduced demand for the product; increased competition; inflation or high interest rates; or similar factors.
It’s rare for a business jet to be significantly depreciated due to Physical Deterioration, except in the case of a non-corrosion related structural damage event. Normally either Functional Obsolescence (i.e. Dispatch Reliability) or Economic Obsolescence (RVSM, Stage-III, ADS-B, etc.) are the big factors that may significantly depreciate an older business jet.
It is important to remember that depreciation as it is defined in appraisal practice, is different from depreciation as it is defined in accounting practice where: “The amount of accounting depreciation taken over the life of an asset cannot exceed its cost. Once the net book value reaches zero, no more depreciation is taken. However, the ‘fully depreciated’ asset may remain in service and still have a value for valuation purposes.”
To date, the average year of manufacture for the entire segment of business aircraft that have been retired, withdrawn from service, or written-off is 1975 (44 years old). That average is from ~7,000 business aircraft (~4,000 of which are jets).
Aside from the tragedies of accidental destruction; reasons for the retirement of these aircraft may have included:
- Excessive Fuel Consumption
- Inability to Comply with Noise Requirements
- Lack of Available Service and/or Support
- Lack of Available Parts
- Technical Mandates and/or Regulations
Part-Out Value Analysis
When an owner contemplates that their business jet might be nearing the end of its useful life, a ‘Benefit to Cost’ analysis, accounting for the time-value of money must be performed. (This analysis might be eliminated by a damage event.)
While there are too many unique variables specific to the aircraft owner that must be considered when a Benefit to Cost analysis is performed, and an example is beyond the scope of this article, I have studied a plethora of ‘Residual Value’ tables, the demography of the retired business jet fleet, damage diminution standards and other factors with the aim of providing an opinion on the value of an End of Life Aircraft (EOLA), from new delivery to scrap, as compared to the expected Residual Value over a 20-year period.
First, we must look at an overview of some of the models that constitute the retired fleet. Table A shows the percentage of diminution (number of aircraft built, versus number of aircraft still active), current age of the oldest active aircraft of each series, as well as the projected (in some cases ‘surpassed’) 20-year milestone of the oldest active aircraft of each series.
Through analysis, the following conclusions can be drawn in relation to where the ‘sweet-spot’ to part-out an End of Life Aircraft could lie:
- The highest part-out values (POV) are found when fleet diminution is less than 10%.
- POV is higher than fair market value (FMV) from 0% of fleet diminution (FD) to just below 4% (POV equals FMV at 4%).
- Then POV is higher than FMV again until 8% is reached (POV equals FMV again at 8%).
- At the 10% FD boundary, both values start dropping at an accelerated rate.
- At 15% FD, both POV and FMV plummet.
For illustration, please refer to Chart A, providing the EOLA value of a 1995-model Gulfstream GV compared to its residual value. (The graph depicts a value diminution damage event occurring in Year 20.)