Leasing pre-owned aircraft: piece of cake or headache?
Commercial aircraft currently in use by airlines have a lifecycle of around 30 years. For example, a Boeing 747 is designed to withstand approximately 150,000 flight hours and the asset is usually being phased-out when the aircraft is in its late 20s. The maintenance status is thus one of the most important factors influencing asset value over time. Thus, success or failure in the aircraft leasing market depends on being constantly in the know regarding the maintenance status of the assets, which becomes incrementally important with aging aircraft. In fact, the engines of a new narrow-body aircraft account for around 25-30% of its value, with the share continuously increasing as time passes, accounting for nearly the total value as the unit approaches 20 years of age.
The importance of proper maintenance cannot be emphasized enough, says Tomas Šidlauskas, VP of Sales at AviaAM Leasing.
„The aircraft retains its value only when it is maintained properly at reputable MRO, and all of the strict international requirements are abided,” Tomas Šidlauskas told in an interview with AeroTime. “Then, the next buyer has a clear understanding of the status and the value. It also means that the asset can serve for a longer time and generate higher revenue; at the same time, the operations of the airline see no interruptions due to aircraft failures.”
The question of value
One of the basic issues that lessors have nowadays is that there is no central database that could provide an accumulation of transaction data, according to Paul Leighton, Managing Director of AVAC. In the past, there have been several attempts to create a database of this kind but this was never achieved due to confidentiality reasons.
As Rob Watts of Aerotask explained to AeroTime, the main difference of why aircraft assets differ from other classes is the availability of transaction data.
“Unlike equities, where billions of data points are generated daily, aircraft transactions occur in much smaller numbers; and the information related to those transactions is often held in confidence,” Rob Watts said in an email.
“There needs to be more focus on Market Values and less emphasis on Base Values,” Paul Leighton told AeroTime in an email. “Base Values – whether current or future – can be virtually anything that the appraiser wishes the value to be whereas Market Values or Market Lease Rentals seek to reflect the actual market conditions.”
Values of aircraft are increasingly being enhanced by the use of full-life maintenance status, making the potential profit for owners more attractive. According to AVAC’s Paul Leighton, aircraft have traditionally valued on a half-life basis, and at the end of the lease or financing were assumed to be returned in a half-life condition, but more recently there has been an assumption of the aircraft being returned in full-time condition.
„As aircraft age, they tend to have higher maintenance costs,” David Wyndham, President of Conklin & de Decker, told AeroTime. “Part of that is due to increasing maintenance inspections associated with aging aircraft and part of it is due to increasing unscheduled maintenance. When evaluating pre-owned aircraft, maintenance condition is a very important part of the price. This is especially true for high-cost items such as engine overhauls and major airframe inspections.”
Generally speaking, values are supposed to drop when such inspections and overhauls are past their mid-life and value is added back for lower than mid-life. Let’s say, engine overhauls are due every 8,000 hours. For an aircraft with 4,000 hours, there would be no adjustment for the engine status. If the aircraft engines have 7,000 hours, then the selling price would be reduced due to the age of the engines.
“Guaranteed hourly maintenance programs will tend to eliminate this fluctuation in value save for a buyer still knowing that for a high-time event, even if covered by the plan, time down from the flight schedule will be necessary to accomplish the check,” David Wyndham adds.
Enter cash adjustment
Having the assumption that aircraft are returned in full-life condition in mind, it is necessary to understand the fact that aircraft are unlikely to be returned in such an artificially sustained condition. For this reason, a cash adjustment is included. The cash adjustment takes the actual dollar cost of performing the necessary maintenance to achieve full-life status.
“There has been discussion as to whether the use of the cash adjusted figure reflects the actual value of an aircraft in full-life or whether such a method more reflects financial engineering,” Paul Leighton, Managing Director of AVAC, explains. “The aircraft can, therefore, be returned in half-life and the operator pays the owner a cash sum to compensate for the lesser physical maintenance status compared to the return conditions, a method which does not benefit the potential buyer”.
The older the aircraft, the greater proportion of the aircraft value is represented by its maintenance status, but definitely not all buyers would be willing to pay the full dollar cost of physically taking a pre-owned aircraft to full-life condition.
“For example, the half-life value of an older B747-400 is currently $25 million,” Paul Leighton continues. “To take the aircraft from half to full life may cost more than $14 million as all the life limited parts would need to be replaced, the engines overhauled, a D-check performed and the landing gears and APU also overhauled. Adding the $14 million to the $25 million half-life value creates a full life value of nearly $40 million. There is little likelihood of a potential buyer paying a premium of $14 million for an aircraft in a physically full life condition but which is already 20 years of age”.
If something goes wrong: preparation is key
“The most important thing is to ensure that the maintenance documentation is handled properly, and that aircraft maintenance is performed only by approved companies that can technically assess the aircraft,” Tomas Šidlauskas, VP of Sales at AviaAM Leasing, told AeroTime. „When the aircraft is in good hands and the documentation is handled according to international standards, all stakeholders know what state it has, let’s say, in its fifth year of operation”.
Surely, not always everything goes as planned and a bad decision in the beginning of the lease period can cause losses in the long run. Being ready for black swan events such as airline bankruptcy and having a backup plan is crucial.
“One of the worst things that can happen to a leasing company is when an aircraft is returned earlier than planned,” Tomas Šidlauskas, who will be speaking at the Aircraft Seminar Management Seminar in London, explains. “This means not only the company having to invest resources in aircraft status valuation but also high legal costs. Today, one of the most visible examples of such a conundrum is the restructuring of Alitalia and airberlin.”
In such a cases, according to Tomas Šidlauskas, lessors have to evaluate the situation of an airline and come up with a strict decision to either:
Keep the aircraft and wait until the last minute, hoping that the airline will be saved
Repossess the aircraft at the right time and minimize losses.
Waiting until the last minute might result in a situation, where there the potential client has many more options to choose from (as the number of available aircraft increases). In this case, it might difficult to get a deal on favorable conditions for the lessor.
“Lessors need to decide what to do with the aircraft after repossession,” Tomas Šidlauskas concludes. “The lessors will have to evaluate the technical status of the aircraft, possibly change the cabin layout, and assess the possible lease conditions. This is why having a back-up plan in terms of re-leasing the aircraft is a must.”