By Anthony Kioussis
President, Asset Insight
Price and value are terms often used interchangeably to describe an aircraft’s worth. However, they actually have different meanings. Price is the monetary amount an aircraft buyer pays, while its value is the relative worth, utility and/or importance they place on that asset.
Emotions can overcome logic during the aircraft acquisition process. All other things being equal, whether an aircraft carrying a “low price” represents “good value” requires detailed analysis focusing, in large part, on its future mx requirements and estimated Residual Value.
The first 2 areas a prospective buyer should consider are (1) the length of time they anticipate owning the aircraft and (2) how many hours per year they intend to fly. This will allow for a realistic projection of the aircraft’s scheduled mx costs during the planned ownership term (see Table A).
This calculation is neither linear nor simple, and costs that are assumed to be minimal may be much higher than anticipated.
Scheduled mx costs increase over time due to more comprehensive airframe inspections and more expensive engine events.
While some view airframe maintenance costs as relatively minor, that thinking can be misleading. A good rule of thumb is to assume that airframe maintenance will run about 90% to 110% of the cost for a double-engine overhaul over the same operating time-period.
Accordingly, if a 5-year ownership term is anticipated and the aircraft’s utilization is expected to require engine overhauls every 10 years, it would be wise to expect airframe mx expense to total approximately half the cost of a double-engine overhaul perhaps more for an older aircraft.
The owner should carefully consider the cost of scheduled engine mx if the aircraft is not enrolled on an Hourly Cost Mx Program (HCMP), as mx expense based on “Time & Materials” will undoubtedly increase over time.
Furthermore, the cost to enroll the aircraft on HCMPs needs to be considered, as not enrolling an aircraft at time of purchase would increase the owner’s financial risk during the ownership period, not allowing them to benefit from the program’s value to the owner during their ownership term (see Professional Pilot, Dec 2017), and the aircraft may still require HCMP enrollment at time of resale to make it marketable due to its Mx Exposure to Ask Price Ratio (ETP Ratio).
The ETP Ratio is a useful indicator of an aircraft’s marketability and it is computed by dividing an aircraft’s Mx Exposure (the financial liability accrued with respect to future scheduled mx events) by the aircraft’s Ask Price.
Days on Market analysis has revealed that when the ETP Ratio exceeds 40%, a listed aircraft’s Days on Market increase by more than 30%. For example, aircraft with ETP Ratio exceeding 40% during Q2 2018 were listed “For Sale” an average of 72% longer than aircraft with ratios below 40% (291 vs 169 Days on Market, respectively).
It is important to understand that the ETP Ratio has more to do with buyer and seller dynamics than it does with either the asset’s accrued mx or its price. For any aircraft, mx can accrue only so far before work must be completed.
But as an aircraft’s value decreases, there will come a point when the accrued mx figure equates to more than 40% of the aircraft’s Ask Price. When a prospective buyer adjusts their offer to address this accrued mx, the figure is all-too-often considered unacceptable to the seller and a deal is not reached.
It is not until an aircraft undergoes some major mx that a seller is sufficiently motivated to accept a lower figure, or a buyer is willing to pay a higher price, that the aircraft transacts.
Residual Value projection should be undertaken to understand the potential loss in aircraft value over the ownership term.
Traditional Residual Value forecasts start with an assumed Current Value that is then degraded based on the aircraft model’s average historical annual depreciation percentage. However, historical values and trends really play no role in an aircraft’s future financial behavior.
Therefore, care must be taken to obtain Residual Value figures from an entity that employs an objective methodology allowing each asset’s value to move independently (as it would in the real world) based on its mx condition/requirements and proven forward-looking market indicators.
Another problem with many Residual Value projections is that the aircraft’s future mx condition, perhaps the most important value influencer, is not accounted for appropriately, if at all, nor is the aircraft placed into context relative to future comparable assets.
While a Residual Value Trend line can be “indicative” of the aircraft’s general value trend, it is more important to understand the Actual Residual Value figure that is likely to occur due to anticipated mx event completions based on the aircraft’s planned utilization.
By way of example, Table C makes a Residual Value projection. The blue line represents the aircraft’s “trend,” while the black line represents the asset’s “actual” projected value due to mx events that are completed, and the influence of comparable models in view of their individual mx status.
The green shaded area displays the comparable aircraft range, thereby placing the subject aircraft into context.
Maintenance expense If the owner plans to finance their aircraft, establishing and regularly updating a mx-leveraged Residual Value estimate and overlaying their loan amortization information will allow them to determine if an aircraft replacement might be warranted sooner than originally planned.
Notice that in the sample graph on Table D, the aircraft’s amortization (orange line) is very close to the estimated Residual Value at the end of the loan term.
Maintenance changes due to increased (or decreased) flying, and or market value fluctuations, could move the Actual Residual Value line lower, possibly causing an unnecessary reduction in the investment’s originally anticipated economics.
Lastly, dividing the aircraft’s forecasted Mx Expense by the estimated Residual Value figure covering the same time-period will allow the owner to determine if their ETP Ratio at time of sale is likely to exceed 40%. If that appears to be the case, the owner may wish to replace the aircraft sooner than originally planned.
Alternatively, they will at least know they must seriously consider offers that are lower than desired. A “low price” is easy to determine. “Good value” is derived through the financial optimization of the owner’s investment by:
• Acquiring an aircraft, at a reasonable price, able to perform the mission requirements.
• Correctly projecting mx costs during the ownership period, in part through HCMP enrollment.
• Limiting scheduled mx expense not covered through HCMP based on detailed analytics of the aircraft’s future mx requirement at time of purchase.
• Securing science-based, objective Residual Value analyses on an ongoing/regular basis.
• Remarketing an HCMP-enrolled aircraft on a predetermined date when its ETP Ratio is below 40%.
Anthony Kioussis is President of Asset Insight, which offers aircraft valuation and aviation consulting services. His 40+ years of experience in aviation includes GE Capital Corporate Aircraft Finance, Jet Aviation, and JSSI.