In over 28 years of dealing with aviation leases, one of the industry “hot buttons” is still the reversion clause. The reversion clause address what happens to improvements on an airport leasehold during the term of or at the termination of a lease. Usually, ownership of improvements made by a tenant reverts to the airport sponsor at some point during a lease, usually at the end. It is at this time of reversion when the airport begins to receive rent on both the land and improvements at their prevailing market rent, as opposed to just charging ground rent. Some airports require that improvements transfer to the airport upon completion, but are not subject to rent until a set point in the lease. Other airports grant long-term leases of 30 to 40 years, but have a provision in the lease where the improvements revert during the lease, usually after 20 years, but the tenant maintains the right to occupy the property for the full lease term, albeit at a higher rent after reversion occurs.
Reversion can also take other forms. In some instances, reversion can mean that at the termination of a lease, the Lessor can require that the tenant remove them at their own expense and bring the site back to its original unimproved state. Regardless, in simple terms, the reversion clause simply addresses what happens to ownership of improvements and their responsibilities at some point during the term of a lease.
Airports are not special
Airports are special in a lot of ways; however, leases are not one of them. Time and time again I have had airport management and current/prospective tenants state that airports are the only ones that have reversion clauses in their leases. This is not true. Reversion clauses are a standard condition in any ground or facility lease. In speaking with commercial real estate brokers around the country, every one of them stated that reversion is a standard clause in every lease that they have negotiated on behalf of a tenant or landlord. In the general real estate market, property owners elect to enter into a ground lease on their property because for a variety of reasons, they choose not to sell their property. In the aviation real estate market, ground leases exist because the airport sponsor cannot sell their property. In addition, from the airport’s standpoint, the reversion clause provides for future revenue streams and the control/management over airport development and facility maintenance.
What about the FAA’s position? According to FAA representatives I have spoken with, they recommend reversion clauses to make it clear to the tenant what happens at lease termination. Interestingly, they further indicated that their interpretation is that if the lease is silent on the issue, it automatically reverts to the airport since tenants cannot own the public land. Regardless, the most common response from the FAA is that regardless of any legal considerations, reversion clauses are just a good business practice for airports. It provides for the future benefits of an enhanced revenue stream that comes from leasing land and facilities.
Facility maintenance suffers because of reversion
A common theme when addressing the negatives associated with reversion clauses relates to the concern that tenants will not maintain their facilities if they are just turning them over to the airport at the end of the lease. First of all, while this might sometimes occur with private hangars (often out of spite), it is not typical of commercial facilities. In part this is due to the fact that a tenant operating a business out of a facility tends to maintain their facilities due to public perception, safety, and otherwise reduced operating costs. Nevertheless, there is a way to address this concern.
What is becoming a standard lease condition within leases is requiring tenants to provide “Condition Assessment” reports on their facilities during the term of the lease. How this works is the tenant is required to have a professional engineer or building inspector perform an assessment of the condition of the facilities at set intervals during the lease, typically every 5 years in a 20 or 30-year lease, as well as within the last year of the lease. (The engineer/inspector is hired by and paid for by the tenant, but must be approved by the airport.) This Condition Assessment will look at the building’s structural components, as well as items such as the electrical and plumbing systems, heating and air conditioning system, etc. If the tenant has parking lots or aircraft ramp/apron on their leasehold that they are responsible for, then those are assessed too. This provides a baseline for the airport to insure the facilities are being maintained beyond what is basic “wear and tear” over time. If there are major items of deferred maintenance, then the airport can make sure they are addressed both during the term of the lease, as well as before reversion occurs. By having this assessment done on a scheduled basis during the term of a lease, it sets forth clear expectations for both parties.
Another benefit of the Condition Assessment is to provide the airport with comprehensive information about whether they even want the improvements at the end of the lease. As stated above, the reversion clause simply addresses what happens to ownership of improvements and their responsibilities at some point during the term of a lease. In many cases, and in my opinion it should be all cases, the terms of the reversion clause provide the airport sponsor with the option of whether to retain ownership of the improvements at the end of the lease, or to require the tenant to remove the structures and bring the site back to a site-ready development parcel. This is an important option for the airport sponsor when regardless of the condition of a facility, it is no longer functional to serve the type of aviation activity at the airport, or the property is needed for an alternative use.
If you don’t renew my lease at ground rent, I will go to another airport
The reversion clause has caused more than one airport tenant to threaten to leave the airport if they have to start paying rent on the improvements. More times than not, this is merely a negotiating strategy. The reality is that there are many more factors beyond a rent increase that will impact a tenant’s ability to relocate. For example, if you are dealing with an aircraft manufacturer or MRO, the requirement to effectively “start over” with hiring and training a new labor base is much more cost prohibitive that even a significant increase in rent. No to mention the fact that wherever they move will either require them to build a new facility or lease and retrofit an existing one. While there are a few communities that might be willing to bite the bullet and cover some of those costs, they will still have a hard time overcoming the employment factor.
With cargo carriers, they are probably at your airport because that is where their operating metrics tell them that they need to be to serve to region, not because their rent is cheap. Several years ago, I was approached by airport that was going to be the next “FedEx Regional Hub”. When I contacted FedEx to find out about the reality in that statement, I was told that they would probably never move from their current airport, because “that’s where the people are.”
The loudest screams probably come from the private hangar owners. These are the folks that “knows somebody,” or worse “know somebody that knows somebody” that can get them fired, or at least get them the deal they want. However, a survey we performed several years indicated that the number one reason that an aircraft owner selected their particular home airport was proximity to their home or office. Price was 4th on the priority list. So unless the individual has moved closer to another airport, the threat is probably an idle one.
The risk of letting that private hangar owner “win,” is that it will set a precedent for every other deal in the future. There is no such thing as a “special deal just between us” anymore. Everybody wants to brag about the deal they made, and then everybody wants that same deal or better. The enforcement of the reversion clause on these types of tenants must be enforced diligently at airports, because these are the deals that can impact all of the larger, more substantial deals at your airport.
Many tenants will claim that they were not aware of the reversion clause in the lease. This usually occurs when the leasehold is sold during the term of the existing lease. However, ignorance is not a valid excuse for a condition in a lease not being enforced. Nevertheless, since politics will usually play a role in this type of dispute, it is recommended that the airport sponsor makes it a habit to remind their tenants of pending reversions on an annual basis. This can be handled in notifications about scheduled lease rate adjustments, requests for updated insurance certificates, or other written communications between the airport sponsor and tenant.
Are there any other options?
While the inclusion of a reversion clause is the industry standard in ground leases, both at airports and in the general real estate world, there are some airports that have looked outside the box. For example, one airport offers a 50 percent discount on the improvement portion of the rent for corporate hangar tenants that are renewing ground lease. These tenants must have maintained ownership of the leasehold for a minimum amount of time before the ground lease expires. Most importantly, the “discount” is not transferrable if the incumbent tenant sells their lease to another party.
A few airports offer two types of leases: reversionary and non-reversionary. (Most of these are airports that had only non-reversion leases and were looking for a way to escape that cycle). In the non-reversion lease, the improvements do not revert, but the tenant pays a substantially higher ground rent to reflect that the airport is foregoing the future economic benefit of being able to lease the improvements. However, these types of leases must have some type of termination provision so that they do not become perpetual ground leases, in violation of the FAA’s restrictions. In most cases, this is handled by limiting the number of time that a ground lease can be renewed before the tenant must remove the improvements.
In summary, the reversion clause in ground leases is not only limited to airports, but is consistently found in ground leases throughout the general real estate marketplace. In fact, the airport industry is more flexible in their handling of the application of the clause that the commercial real estate market. While non-airport leases typically only offer the option for the current tenant to either lease the improvements or remove them, airports have been creative in finding ways to allow their tenants to remain under circumstances that do not have a significant economic impact to either party. While creativity might be viable in certain cases, it is important for airports to look at the big picture when entering in ground leases by considering not only the present, but also the long-term economic, operational and development impacts on the airport. You don’t want to be the person that your successor mentions every time a bad lease deal comes up under their watch.
Michael A. Hodges, MAI is the President and CEO of Airport Business Solutions, a diverse aviation valuation and consulting company based in Tampa, Florida. Airport Business Solutions assists airports and aviation businesses worldwide on a variety of property, business, operational and marketing issues. Michael is also the President and CEO of ABS Aviation, a contract management company for FBOs and general aviation airports.