Wings & Water: Jet Revenue Stream
The numbers do not lie to Jim Ferraro, a product liability lawyer from Miami, Fla. For him at least, one-eighth of 8 million equals more than 6 million. That is to say, Ferraro has determined that he can save money by giving up his one-eighth share of an $8 million Hawker 800XP and instead purchasing a $6 million 1982 Challenger 600 outright. His math is not fuzzy.
Ferraro says that the up-front costs of his fractional program, plus the management fee, plus the hourly flight charge, put the Hawker’s cost at more than $3,000 per hour of flight. By contrast, he can fly his Challenger at $2,200 per hour (his fixed annual costs of ownership, including financing and storage charges, divided by the number of hours he flies, plus fuel and maintenance costs). Ferraro reasons that if he turns his jet over to a charter company when he is not using it, he can further reduce his costs. "We can put it out there for
100 hours for every 200 hours my partner and I fly," he says. The charter company will charge a rate of $4,500 to $5,000 per hour, and Ferraro will keep 85 percent of that revenue (less fuel costs), which he says can take his hourly flight cost down to about $1,400 per hour. Suddenly, his $6 million purchase is a steal.
Reducing the cost of jet ownership by making the plane available for charter seems like such a sensible idea that it has fueled many jet sales over the past few years. "It’s one of the key sales pitches that you’ll hear out there," says Bill Quinn, president of Aviation Management Systems, an aviation consulting company in Portsmouth, N.H. It is common for jet brokers and manufacturers to use the lure of charter revenue in their sales pitches, telling would-be owners that this is a sure and simple way to defray the considerable costs of maintaining and financing a business jet. However, your broker or salesman might not tell you that chartering is not for everyone. Although you can significantly reduce the cost of ownership by chartering your underutilized jet, you have to possess the right attitude and fit the proper owner profile to enjoy the benefits. You also have to understand the risks and regulatory responsibilities that go along with chartering.
Aviation lawyer Harold "Mac" Deason, a partner with Bodman, Longley & Dahling in Grosse Point, Mich., who has advised many clients on how to buy and manage aircraft, says that there are two main challenges to chartering your jet. "First, you have to make sure that your aircraft isn’t abused. Second, you have to go through certain regulatory hurdles, which aren’t cheap." A private aircraft operates under Part 91 of the FAA regulations, while a chartered aircraft operates under Part 135, which requires a higher standard of pilot training, tighter maintenance regulations, and much more paperwork. When you turn your plane over to a charter company or management company, it will be delighted to add your aircraft on its 135 certificate, but it will charge you for the rigorous FAA inspection required to do so. That bill could be from $35,000 for a midsize jet to more than $100,000 for a Gulfstream V. If your plane is not new or does not have top-of-the-line avionics, you can expect to pay more for the maintenance required to make the plane charter-worthy.
Once the plane is on a charter company’s certificate, the charter company has complete control over who flies it and who flies in it, unless your contract specifies otherwise. Owners typically negotiate an agreement with the charter operator about their planes’ availability. This agreement will stipulate the number of days that you will likely use the aircraft and when it will be available for charter trips. It will also dictate if or how the charter company will notify you of a potential trip. Many owners want to be called every time the plane goes out on a charter trip. Some retain the right to refuse certain passengers or certain types of passengers. "Everybody brings up the rock band example," says Tom Seeber, president of Pentastar Aviation, an aviation management company in Waterford, Mich., that operates its own Gulfstream service center and private runway.
" ‘What if a rock band uses my airplane and trashes it?’ We try to tell them that entertainers are some of our best customers. They’re not having wild parties on board. At the end of the day, they want a phone and a fax so they can get some work done."
Seeber advises owners to choose a charter operator with a good reputation. These operators are going to have long-term relationships with clients who are going to respect your aircraft. A well-run charter company also makes a commitment to maintaining the aircraft, either with a dedicated crew or through a relationship with a reputable service center.
Seeber also cautions that liability insurance can be an issue for owners who wish to charter their aircraft. "Look at what level of liability the operator’s policy covers," he advises. "Some have only $5 million in insurance. We carry a minimum of $300 million with an option to go up to $500 million. You should look for at least $100 million in insurance coverage. Any less is a telltale sign of cost cutting."
Mark Bethea, senior vice president of Xtra Jet, an upscale charter company in Santa Monica, Calif., says that the final thing you should consider when looking at charter operators is trust. "It is like taking on a business partner," says Bethea. "This is the person who is going to determine how much it is going to cost you to own your aircraft. Can you call them at 3 am? Who is going to answer the phone at that time—the secretary on the graveyard shift or a senior manager?"
Ensuring that your plane is well cared for is one of the hurdles of chartering your aircraft. Another is determining whether the revenue generated by charter is worth the trouble. Nick Cerretani, president of J. Mesinger Corporate Jet Sales in Boulder, Colo., says that you should choose a charter operator with long-term relationships with customers. "That way, you know that their revenue projections are realistic," he says. Some charter companies are optimistic with their sales pitches, when in fact they have no control over the amount of charter business they will see in the coming months. "One of the biggest mistakes owners make is not adequately understanding, evaluating, and protecting themselves against less-than-optimal revenues," says Cerretani.
Some owners have tried to protect themselves by demanding a guarantee of revenue. Several years ago, when charter companies were in need of planes, they often offered these guarantees. Now, the market has reversed itself. Jet values have fallen, and many owners who cannot afford to sell at a loss are instead turning their jets over to charter operators with instructions to fly them all the time. As a result, charter capacity is greater than demand in some markets, so few charter operators will guarantee the amount of revenue you will earn with them.
In fact, Seeber says that any offer to guarantee a certain amount of revenue should be a red flag for owners. If the charter operator cannot control market demand and he cannot control how many days the jet owner is going to make his plane available, how can he control the amount of revenue he will generate for that owner? "I tell people they had better get that guarantee in writing, and make sure they cut you a check for the difference. That usually changes the dynamic of the guarantee," says Seeber.
Before you look for any guarantees—in fact, before you even approach a charter operator, says Bethea—you should know how much you will use your plane annually. "If you use your airplane more than 200 hours a year, then charter income becomes marginal," he says. To a charter operator, the ideal jet owner is someone who flies 150 hours a year or less. The next thing you should ask yourself, says Bethea, is how important it is for you to fly in your own airplane. Chances are good that at some point during the year, you will want your plane on short notice, only to discover that it is out earning money. How comfortable will you be using a substitute aircraft? If that will bother you, then turning your plane into a revenue-generating product will likely be a frustrating and disappointing experience.
The need to make money from your plane may itself be a bad sign, says aviation lawyer Milton Ferrell, contributing author of the book Wealthy & Wise (Secrets About Money). "If someone takes into account charter income in deciding to purchase a plane, that’s a terrible idea, because you’ll have the cost of ownership even if the economy tanks and you can’t charter it as much," he says. "That can make ownership an uncomfortable experience." Ferrell insists that jet ownership should be enjoyable, that it should make your life more convenient. "Some owners worry about having a plane and a pilot sitting around all the time, but a little underutilization is good," says Ferrell. "It gives us grace and makes our lives more convenient."
Doing the Math
When a jet broker issues a proposal to a potential owner, he might outline the way in which charter revenue can offset the cost of owning a jet. For instance, if you purchase a Gulfstream V at $40 million and finance it at 6.5 percent for 15 years, he will explain, your total annual costs for that aircraft, including financing, crew, hangar space, training, and flight services, will be approximately $4.9 million. A fair estimate of your direct costs for fuel and maintenance is $1,278 per hour of flight.
If you fly the plane 150 hours the first year and it is chartered for an additional 75 hours a month, or 900 hours for the year, at $6,500 per hour, the total revenue generated will be slightly more than $5.8 million. The charter operator will subtract a 15 percent commission on that revenue, or $877,500, leaving net revenues of approximately $4.9 million. The charter operator will further subtract the fuel and maintenance costs, or another $1.15 million.
That gives you $3.75 million to apply toward your fixed costs of $4.9 million, leaving you with a cost of $1.15 million to own a Gulfstream V for a year. That means that each of your 150 hours of flight will cost only $7,667 (plus fuel and maintenance costs). If you had not chartered your aircraft, those same 150 hours would have cost you $32,667 each.
Of course, this represents a best-case scenario. Given the current charter market, 75 hours a month is an absolute maximum amount of hours you could expect to charter your plane. If the charter company can charter your aircraft for only 25 hours a month, or 300 hours a year, at $6,500 per hour, the gross revenue will be $1.95 million. Subtract the charter commission of $292,500 and you are left with net revenues of approximately $1.66 million. Then subtract the operating costs of $383,400 and you have nearly $1.28 million to apply to your $4.9 million annual fixed costs. In this scenario, each of your 150 hours of flight will cost you just over $24,000 (plus fuel and maintenance costs).