The Achilles heel of the fractional jet business model is the residual value that an owner receives at the end of his investment (generally 5 years). I’ve commented on this for many years. Most fractional owners consider the cost of this investment considering the buy in cost for the share and the operating costs (monthly management fees, hourly flying costs, fuel and other surcharges, etc.), but in crunching these numbers they forget to figure in what they’ll get back when they sell the asset. The providers have done everything possible to make sure a secondary market hasn’t developed. Thus, there’s really only one market for these shares—the fractional companies themselves.
Because of this blind spot and an understandable lack of knowledge and experience with the way these contracts work, most prospective fractional owners fail to negotiate the buyback provisions of their contract so that the process yields a fair result.
In addition, when fractional companies offer buy out prices, supposedly based on the value of the underlying aircraft, most owners lack the knowledge and expertise to challenge them.
Thus, in many if not most cases, the fractional provider is able to buy back the share at a significant discount to its fair market value. It is only then, at the end of the deal, that the owner can really determine what it has cost per hour to fly fractionally (the sum of the buy in cost and the operating costs over the life of the investment, less the residual value, divided by the actual time in the air.)
At Shaircraft, we have attacked this problem on behalf of fractional owners for many years—both in negotiating their contracts up front, and in bringing to bear our knowledge and expertise in challenging the low ball residual share values offered by the fractional companies. In one recent case, our efforts increased the valuation of a fractional aircraft by more than $2 million.
It’s no secret that the value of preowned private jets has decreased generally due to the recession. This down market has adversely affected the residual values of fractional shares; but frankly, faced with many more redemptions than new sales, some providers are using the recession as an excuse to low ball their customers. In our next post, we’ll look at a specific case in which a fractional company essentially refused to buyback its owner’s share, despite a clear obligation under its contract to do so.
