Should you pay cash or lease or finance your next aircraft? It’s a great question and one that we often answer for our clients here at Guardian Jet.
Below we’ll compare the different options for aircraft financing in an effort to help you understand its impact on your fleet plan.
But first, let’s see what the industry is doing, domestically here in the U.S., and abroad.
Survey Says . . .
Cash is king.
At least when it comes to buying a new aircraft in the U.S., according to Michael Chase, principal at Chase & Associates.
In his report, nearly three-quarters (73%) of new aircraft owners purchase their planes outright. And this is a statistic that’s remained largely constant since 2006.
But, internationally, things are different when it comes to aircraft finance.
When JETNET iQ’s Quarterly report surveyed 500 aircraft operators globally, only about 45% shared that that they prefer cash—or cash followed by financing—as their preference.
Where international buyers are concerned, financing is more popular.
Yet leasing is gaining considerable traction, thanks to record demand and strong liquidity. It’s an aircraft financing option that creates more efficient risk management of aircraft residual values.
In Boeing’s 2018 Current Aircraft Finance Market Outlook, aircraft leasing continues to grow in absolute size while maintaining a 40% global market share.
So, what is your best option when it comes to aircraft finance?
How do you factor in aircraft residual values? And should you let someone else take on the risk while you use your cash to fund other projects or assets?
Pros and Cons: Cash vs Lease vs Financing
Let’s get down to it and discuss the pros and cons of the different purchasing vehicles. Then we’ll go into an actual example of buying or leasing a $10M airplane.
In an aircraft lease, the pros are as follows:
- You preserve your capital outlay.
You don’t put anything up front, you just start making payments.
- You have fixed monthly payments.
You know your budget for the term of the lease agreement or your ownership period of the airplane.
- You have no residual value risk.
The residual value risk is born by the lessor.
- You have some degree of flexibility.
This is because you can write into the lease deal an EBO (Early Buy Out) or an ETO (Early Termination Option). This can be favorable to you if the market does better than what the leasing company anticipated. You usually don’t impact your P&L in the year of the transaction like you would paying $10M for an airplane.
- You aren’t impacted negatively in the year of replacement.
- You might have flexibility. At the time of sale, the bank may allow you to enter into new lease agreement for your next purchase.
The cons of an aircraft lease:
- Your tax benefits are assumed by the lessor.
You’re giving the residual value risk to the leasing company, and they’re getting the tax benefits. So the lessor gets the depreciation.
- You pay more to own your airplane.
Over the life of the agreement, you’re paying interest and you don’t get the same tax benefits as mentioned above. Also, when you want to sell the aircraft, the optimal timing for buying a replacement may be limited, depending on your lease term and/or exit strategy.
- You will have usage restrictions.
You can only fly it so many hours a year or you affect the return conditions on a lease. A lessor usually has requirements for hours flown, insurance, and being on an engine program.
The pros of financing an aircraft:
- You will save more money.
When financing through a bank, you’ll save the most money from a net present value cost. Aircraft financing is the less expensive option over the life cycle of your ownership from a net present value perspective.
- You get significanttax advantages.
You can accelerate the depreciation of the airplane. (In the example below, we use the current 100% bonus depreciation in year 1, so you’ll reap considerable tax benefits.)
- You have more flexibility to resell.
There are no restrictions on how you use the airplane. And you’ll be able to sell the plane more easily, without lease penalties.
The cons of financing an aircraft:
- Your capital is tied up.
Let’s say you pay 10% for a $10M jet. That means you’re going to put $1M down, and you can’t use that for other business needs—the way you could if you were leasing the airplane.
- You assume the residual value risk.
- Your P&L might be impacted negatively.
This is because you’re spending $10M in the year of the transaction.
The pros of purchasing an aircraft with cash:
- You get great tax benefitsfrom owning your own airplane.
- You will save money over time. Cash is the less expensive option over the life cycle of your ownership from a life cycle cost perspective.
- You have the most flexibility when you sell.
If your corporate travel mission changes, you can sell more quickly without lease penalties, and there’s no loan to pay off.
- You have no transaction costs.
- You have no restrictions.
This enables you to use the aircraft as you wish, and choose whether to add an engine program (it’s not required). Excessive wear and tear is not an issue (at least to the lessor).
The cons of purchasing an aircraft with cash:
- You will have a significant capital expenditure.
- You assume the residual value risk.
- Your P&L might be impacted negatively.
Financial Analysis Case Study – After-Tax Cash Flow
In the following case study, we looked at financing options for a nearly new aircraft that’s less than three years old and has fewer than 1,000 hours. The purchase price is $10M, and we outlined both the 10-year life cycle cost and the net present value.
Our assumptions for a 10-year cash flow example:
- Compared the cost of capital over a 10-year term calculating after-tax
- Sales tax rate of 8.25%
- Residual value decrement of 8% per year
- Federal and State corporate tax rate of 35%
- Net present value discount rate of 10%
- 100% business use
- Lease rate factor of 0.9%
- Financing interest rate of 4%
- 100% bonus tax depreciation for after-tax analysis
10-Year Life Cycle Cost and Net Present Value Case Study – $10M Jet Purchase
Ok. Now, let’s get into the specifics. Looking at the chart above, the blue lines represent the life cycle costs of owning the airplane over 10 years.
In the first column, the cash purchase has a very low life cycle cost.
But when you apply the cost of money or the net present value (NPV), it’s very high. In fact, it’s much higher than the life cycle cost because in the beginning of that term, you paid $10M.
Life cycle cost explained:
You buy the airplane and pay for it, including all the operating costs. You get the tax benefits, if any, and then you sell the airplane. Or, in the case of the lease, terminate the lease at the end. And then you look at your total costs.
Net present value explained:
The value of a sum of money in today’s market, in contrast to some future value it will have when it has been invested at compound interest.
In an aircraft lease, you’ll have high life cycle operating costs because you’re paying a lot of money over time to lease this airplane.
But, unlike in the purchase, because you’re paying it over time (and it becomes a discount rate), you actually have a lower NPV than your life cycle costs.
It’s much less expensive to pay with cash than to lease, but you can see the difference, and remember that there are some advantages to leasing.
In the third column, you’ll see that financing the airplane clearly comes out ahead from a net present value perspective. This is due to the lower capital outlay combined with the ability to reap the benefits of the 100% bonus depreciation.
With all of that said, every aircraft ownership decision is unique to the corporate or high-net-worth individual.
We’re always more than happy to discuss your particular needs. To learn more, visit our financial projections page or give us a call at 1-203-453-0800. We’d love to help you out.