Lease adjustments in an unstable economy

The current economy has brought about an issue that could have negative financial implications for years to come — that is, scheduled rent adjustments. 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 the 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”.

Starting around 2003, the industry started on an upward trend. By 2006, the trendline was at a sharp upward angle in almost every segment of the industry. 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 few saw coming 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, which 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. 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.

Different reactions

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.

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 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.

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. In fact, most FBOs are struggling to get back to 2003 or 2004 levels.

So, 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?

In my opinion, it’s not an airport’s responsibility to modify lease terms solely to benefit the tenant. If the market shoots up and the airport doesn’t have the ability to adjust rents, should an airport reasonably expect a tenant 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.

From a valuation standpoint, the challenge in determining appropriate rates and charges at airports is that they are always based on historic data. The reality is that we are probably in an environment where data from 2003 and 2004 is more representative of today’s aviation marketplace.