The current economy has had an impact on virtually everyone in the aviation industry. No one has gotten away unscathed. An issue that could have negative financial implications for years to come relates to a scheduled rent adjustment. Due to poor timing, many FBOs and other tenants have been facing the reality of rent adjustments at the same time that they are dealing with other realities of this down economy. At the same time, airports have been struggling with how to handle these adjustments, without impacting their own bottom line. In many cases, the result has been an economic “tug-of-war” of epic proportions.
Starting around 2003, after the industry reorganized itself after the events and after-effects of 9/11, the aviation industry started on an upward trend. By 2006, the trendline was at a sharp upward angle in almost every segment of the industry. During this time, businesses were being bought and sold at a pace only exceeded by the rate of growth of the dollars associated with each transaction. At the same time, new leases were being executed and promises were being made regarding capital improvements and investment. Zeros continued to be added without regard to the debt associated with getting the deal done. Tenants were more than willing to agree to whatever the airport requested, which typically included provisions for periodic rent adjustment. Airports assumed that this adjustment would always be upward (and most leases guaranteed that rents would be stagnant at worst), while tenants did not care. Growth in revenues would more than cover anything the airport might want when the time came to pay up.
What no one in the industry expected (or at least wanted to admit was highly possible, if not likely), was that we were due for a massive “correction.” Corresponding with downward trends in most real estate markets and values, airports were experiencing 30 to 40 percent declines in flight operations and, more significantly, fuel sales. The decline in fuel sales meant not only less revenue for FBOs but also airports, who were benefitting from expanding fuel flowage fee revenue streams. Aviation businesses began to realize that the belt could only be tightened so far without there being a negative impact on customer service and safety levels. At the same time, airport management was dealing with the same issues. All of a sudden, the day of reckoning came when the previously forgotten scheduled lease rate adjustment date arrived.
Many smaller airports like the Minden-Tahoe Airport just “bit the bullet” and chose to forego the scheduled adjustment, realizing that they were all in the same boat and that any rent increase at that point in time might serve to push many of their businesses over the financial ledge. In many instances, airports even went so far as to do temporary rent abatements until business recovered. From a purely “do what’s right for the community” position, this was clearly the appropriate path for many airports. However, from a business perspective, it had some obvious negative ramifications for the airport. Some projects had to be tabled and reserves had to be tapped. From the tenant’s standpoint, they appreciated the rent abatement or stability, but realized that this was only temporary, and in many cases, the lost rent would be made up in future years. Most importantly in the whole process: the realities of the tenant/landlord relationship were recognized that a lease is a partnership. And with all partnerships, there has to be some give and take on both sides for both parties to reach their long-term goals.
In certain situations around the country, the airport’s answer to the fledgling economy and struggles of their businesses was “full steam ahead”. This meant that despite the current economic environment, the airport was proceeding with scheduled rent adjustments as planned. However, many businesses were fine with this approach, assuming that since it is a “current” rent adjustment, the downturn in the economy and aviation industry would potentially result in a rent decrease, or at worse, no rent change at all. In fact, leases that were tied to changes in the Consumer Price Index (CPI) were only met with nominal increases of less than 1 percent. While difficult to stomach any increase given economic conditions, such a small increase was tolerable for most operators.
Unfortunately, other businesses experienced a major shock when they received their airport letter. Some airports indicated an intention to increase rents significantly, despite no or little market information to support such an increase. Airport sponsors like King County in Seattle, owners and operators of Boeing Field, proposed a 60 to 100 percent increase for their 2009 scheduled adjustment over the last adjustment in 2006. The resulting increase imposed upon tenants at Boeing Field ultimately ended up lower; yet, despite clear evidence of 30 to 40 percent declines in local real estate values and airport activity, there was a sizeable increase in rents that may ultimately spell financial doom for some of the long-standing tenants there.
As noted earlier, there were some sharp increases in the aviation industry being realized in 2006 and 2007, and even in the first half of 2008. However, as the election approached, things started to slow down, until the ultimate slide started in early 2009. This is significant information, because for tenants that were on a five-year adjustment cycle that started in 2004-2006, there were some periods of rapid increases realized in the early years. Unfortunately, over the past two-plus years, all of the growth realized prior to mid-2008 was wiped out … and more. The downward cycle of aviation operations and fuel volumes over the past two years has more than offset the previously realized increases. In fact, most FBOs are struggling to get back to 2003 or 2004 levels in today’s market. This also typically correlates to what an aviation business can reasonably afford to pay, and probably should pay based upon market trends and activity levels in today’s marketplace.
So what does that mean from the airport side of the equation? Is it an airport’s responsibility to adjust their rates downward if the lease terms do not require them to do so? Is there a dangerous precedent if a scheduled increase is skipped? Is it in the best long-term interest of the airport and its tenants and users to continue to table needed capital projects? These are some of the difficult questions that face airports in today’s marketplace.
In my opinion, it is not an airport’s responsibility to modify lease terms solely to benefit the tenant. If the market shoots up and the airport does not have the ability to adjust rents, should the airport reasonably expect the tenant to come to them to offer to pay more rent? Probably (absolutely) not. However, leases are the ultimate form of a public/private partnership. Each side has something to gain from the other’s success. As such, in certain circumstances it may be prudent for the airport to pass on a scheduled increase, or at least defer it for a few years until the situation stabilizes. A possible scenario might be for the airport to consider short-term rent abatements to “current market levels” to normalize the economic environment among the airport’s businesses. This abatement would be accompanied by a lease provision for the airport to recover the abated rent in later years of the lease. Rent deferral cannot be a permanent or even long-term solution, but could serve as a viable alternative to what is hopefully going to be a short-term issue at this point.
What about airports taking the “hard-line” approach by saying, “If you want to be here, these are our rates”, and the rates are excessive in a tenant’s opinion? Well, the reality is that every airport has the right to run its business the way that is best for its situation. In some circumstances, the airport may be correct in setting rates with this mindset -- for example, if demand far exceeds supply or if the rates were artificially low in the first place. (The “artificially low” argument is often used but not always supported by data.) While from a business development perspective, this approach may not facilitate good landlord/tenant relationships, airports, like private businesses, have to make difficult and unpopular decisions at times.
The risk of a “take it or leave it” approach for an airport is that they often price themselves out of the market, at least temporarily. This is especially true for airports with a heavy influence of corporate flight departments and private hangars. The position of many airports is that “land is land” and if they have corporate operators that are willing to pay whatever to be at a particular airport, then that must be the market. However, there are distinct differences in what a corporate entity can and is willing to pay for privacy and security, compared to an aviation business that is focused on generating sufficient revenue to cover overhead and generate a reasonable level of return on their investment. Regardless, with many small airports on the outskirts of metropolitan areas getting more aggressive in their marketing efforts against their more metro-centric competitor airports (the Collin County Regional Airport outside of Dallas, for example), the lure of heavily discounted rents, cheaper fuel, and a “we want you here” attitude, has caused many flight departments to re-evaluate their options.
From a valuation standpoint, the challenge in determining appropriate rates and charges at airports is that they are always based on historic data. In other words, today’s rates and fees are almost always estimated based upon what happened a year or more ago. While the same methodology applies to the general real estate world, there are many more transactions from which to draw conclusions on trends in the market. In the world of airports and airport properties, you may only have one transaction at an airport every two or three years. Moreover, in the current economic environment, the last real transaction is often back in 2007 or early 2008, prior to the bottom dropping out. Without careful analysis, relying on this data can result in unsubstantiated increases in today’s market. The reality is that we are probably in an environment where data from 2003 and 2004 is more representative of today’s aviation marketplace. While it is difficult to fathom going back that far to support a rental rate base for an airport, the reality is that many of the businesses on the airport have had to go back that far to find a similar level of revenue generation.
While we are starting to see some positive movement in the industry, the “new reality” should still be fresh in the minds of airports and tenants. Both sides will be in the recovery phase for years to come, which will undoubtedly impact the way existing businesses approach the terms and conditions of their current agreements, as well as the way new leases are negotiated by both parties. As an airport, you need to think about whether you would rather have financially stable and successful businesses that pay their rent on time, invest in marketing their business and the airport, and look for expansion opportunities. These types of tenants are much better than the disgruntled one that is constantly on the airport’s doorstep complaining about the unfair way they are treated, and how they are looking for alternative, more business-friendly locations to grow their business
As an FBO or other aviation business, you need to consider whether you would rather pay a little bit more in rent and have an airport that is financially stable and investing in its infrastructure, or would you rather pay the least amount of rent possible but constantly have to deal with an airport with high staff turnover and failing infrastructure. As a tenant, the goal should be to send a check to the airport once a month, and never have to see airport staff on terms other than your own.
The last few years have not been the greatest time in history to be in either airport management or an aviation business. The good news is that it will get better, although no one is certain when. Regardless, the goal of everyone in the industry should be to work together to muddle through the challenges of today, and realize that approaching situations as partners, instead of adversaries, will probably result in a win-win situation for all parties tomorrow.
