Many shocked as frax values drop
Fractional aircraft owners who were assured five years ago–when business aviation was booming–that their shares would retain 75 to 80 percent of their value are discovering to their dismay that those shares have in some cases retained as little as 50 percent of the original worth. “It’s the first real test of the fractional-ownership system,” said one observer, “and some of the share owners aren’t liking what they’re seeing.”
According to Mike Riegel, founder of the Dallas consulting firm Fractional Insider, shares are not only being revalued at considerably less than anticipated; if the share owner opts to leave the program and sell his share back to the provider, “He’s being charged a resale fee of as much as 12 percent of the revalued share.”
Riegel’s perspective reflects the name of his company, to wit, that of an insider. Most recently, he was vice president of marketing and sales for Bombardier’s Flexjet fractional-ownership program where he dealt with some 500 fractional customers and participated in more than 2,000 transactions. After a contractual one-year no-compete period following his departure from Flexjet last year, Riegel launched the consulting firm of Fractional Insider (www.fractionalinsider.com) and the bimonthly newsletter of the same name.
According to Riegel, shareowners opting to leave a program and sell back their shares to the operator before expiration of the contract may get an even bigger shock. In addition to a resale fee that ranges from 4 to 12 percent, he explained, some operators are also including a “liquidated damage fee” as high as 20 percent of the value of what the operator deems to be the current share value.
“Aircraft prices are a volatile commodity,” said Mike Silvestro, v-p of sales and marketing at frax provider Flight Options, who cited as the primary reason the inventory levels of used aircraft. “With increased inventory, prices are down, and that’s true for fractional and whole aircraft. It’s all about timing–when you bought, and when you exit.”
At the same time, Silvestro said with regard to clients leaving the Flight Options program for whatever reason, the company has “never had a situation where we have not been able to come to an amicable agreement. We have had clients disappointed in the situation, but not with the program.”
The revalued amount varies, depending on a number of factors, including aircraft type, cockpit and cabin avionics, total hours on the aircraft, maintenance history, numbers of cycles, date of manufacture, used-aircraft market demand and individual fractional operator policy.
Some aircraft–typically the larger, high-end business jets–have better value retention than others. An aircraft equipped with the latest cockpit and cabin avionics has a high initial value and, if not overtaken by newer technology and government upgrade requirements, it will retain its value better than less well equipped business jets. Fractional aircraft typically ring up between 700- and 1,200 hr annually (about twice the flight hours logged by a similar aircraft in a corporate flight department role), lowering resale value for these high-time aircraft below that of the Blue Book listing. Finally, as Silvestro noted, the resale value of a particular airplane is almost certain to be negatively affected when that aircraft’s inventory level climbs.
According to Steve Phillips, director of marketing for Dallas-based fractional operator Flexjet, the lower revaluation of fractional shares is not a surprise, considering the market. “What’s happening in fractionals is the same thing that’s happening in the used aircraft market as a whole, and the revaluation of fractional shares is based on the aircraft values in the used market. The starting point is the Blue Book and share values are adjusted accordingly from there. The process is the same, whether it is a fractional aircraft or otherwise.”
Wings Aviation International, a Franklin Lakes, N.J. aircraft brokerage firm, has been responsible for the resale of numerous business jets previously part of a fractional fleet. Company v-p Joe Carfagna said the Learjet 60 is one example of excess inventory, resulting in revaluation of aircraft below the Blue Book market price. The Learjet 60, manufactured by Bombardier, is a mainstay of the company’s own Flexjet frax program. Flexjet airplanes, said Carfagna, are sold after five years, and this has caused a flooding of the market and forced lower values for this model. As a result, he said, the current market value for a Learjet 60 is anywhere from 10 to 12 percent lower than it might have been otherwise.
If the heavy inventory of used Learjet 60s is having an effect now, it is likely to get worse next year when deliveries of Bombardier’s new, larger Challenger 300 (née Continental) begin arriving. At that point, a substantial number of Learjet 60 share owners who bought into “daisy chain” deals will automatically move up into Challenger 300s. And at the same time, the Learjet 60s in which they formerly held shares will enter the pre-owned market. That is expected to add at least a dozen aircraft to the six or seven that would normally be retired, further depressing the value of used Learjet 60s.
However, Flexjet’s Phillips said the fractional operator accepted only seven Learjet 60s into the program in 1997, which suggests that the same number of used Learjet 60s are being retired from the fractional program this year.
Phillips did not offer firm numbers as to how many Learjet 60 owners would move out of their Learjet 60 and into new Challenger 300s when deliveries of the new airplanes start in third quarter of next year. He also noted that the same incentive had been offered to some Flexjet share owners of other Bombardier business jets, including the Challenger 604, Learjet 31A and Learjet 45.
NetJets Mitigates Impact
Riegel cites as a specific example of revaluation shock the case of one fractional owner who said his operator had advised him that his light-jet share “ought to be” worth about 75- to 80-percent of its acquisition value after five years. When he sold the share this spring after four years, said Riegel, the aircraft was revalued at less than 60 percent of the acquisition price.
Kevin Russell, executive v-p of NetJets, claims that some competitors have taken advantage of the fact that many fractional customers were, and some still are, new to the business aviation industry and relatively naïve in that regard. “In some cases, they bought [into a fractional program] at inflated values,” he told AIN. One fractional provider, he claimed, recently bought two pre-owned Gulfstream IVs for $14 million and $15 million each and was selling the fractional shares based on an aircraft valuation of $23 million and $24 million, respectively.
Russell admitted that NetJets fractional shares are also being revalued lower than originally anticipated, but while reluctant to discuss actual numbers, he added that they are not as low as they might be. NetJets customers are benefiting, said Russell, from the fact that the company buys “aircraft that industry experts agree have the highest residual value–Citations, Falcons and Gulfstreams.” He also noted that as a result of the economy, some NetJets customers have downsized, and “in those cases we have offered to buy the share back and helped them find favorable financing for the new share.”
NetJets’ position, he told AIN, is further enhanced by the fact that the company typically keeps its aircraft in the fleet at least 10 years. As a result, the residual value of the aircraft at retirement is low enough that the effect on the used aircraft market has been minimal. NetJets also does not retire aircraft in batches.
Dealing With Revaluation
So how does the fractional owner deal with lower-than-expected revaluation of his share?
According to Riegel and others, there are a number of steps that may be taken:
• Educate yourself–examine the literature and contract, ask questions and consult experts in the fractional ownership field.
• Buy wisely–ask if the provider has “back fill” shares from previous owners leaving a program. Those shares may be available at a reduced price. Get an independent valuation on the aircraft you are being offered and compare it with the operator’s valuation.
• Manage your share just as wisely–have your share independently valued once a year and work with an advisor who can help you understand what is happening in the new and used market that might lower the value of your investment.
• Don’t settle–if you disagree with the provider’s revaluation of your share, remember your contract probably includes the right to an independent appraisal. In most cases, both the share owner and the fractional provider are required to select an independent appraiser, who then selects a mutually acceptable third appraiser. The majority decision by the appraisers is generally binding.
Riegel emphasized that the fractional providers will generally try to avoid such remedies as an independent appraisal, not because they are unwilling to accept the findings but because of the ill will created by the process, especially since word of mouth is one of key ways people are introduced to the individual fractional programs.