By Roy Norris, Aviation Consultant

Much has been written about fractional ownership over the last year. Few subjects in aviation have produced as Much polarization and strong feeling in the aviation community, pro and con, over a method of use of business aircraft. The picture has been clouded by questions as to whether fractional ownership aircraft are commercial operators under the definitions in the Federal Airworthiness Regulations, concerns over the threat to conventional flight departments which fractional ownership represents, and the unfortunate lack of business ethics some fractional ownership companies have displayed in the marketing of their product. There has been much miss-information provided on both sides of this issue.

Fractional ownership has deeply divided the National Business Aviation Association and threatens to wreck this critically important voice for business aviation. With emotions running so high and most commentators on the subject potentially having their own interests either threatened or served by fractional ownership, it's been difficult to determine the real facts on fractional ownership: its real costs, benefits, and pitfalls.

My observations and analysis presented in this article are based on my experience with fractional ownership companies ­ both selling a lot of aircraft to them and overseeing the startup of Raytheon Aircraft's Travel Air program while I was president of Raytheon Aircraft.

On the surface, fractional ownership seems like a great idea and, in certain situations, it can be. It has great promise as an important new method of delivering the benefits of business aviation to a much broader sector of the market by allowing customers to buy a part of an airplane and then operating it for them for compensation. But customers who's annual flight time requirements would not justify the ownership of a full airplane, or customers that just don't want to be bothered with the administrative burden of setting up and managing a flight department have been led to believe that fractional ownership is a low cost alternative to traditional full aircraft ownership supported by a flight department. In some restricted situations, it is. But in most cases for corporations, it is far more expensive than traditional full ownership. However, one cannot ignore the fact that of recent times fractional ownership has been the fastest growing segment of the business aviation industry.

There are a number of factors that take the bloom off this rose. There are hidden costs that are never pointed out by some traditional fractional ownership companies that dramatically change the cost equation. Further, such misleading statements by some fractional ownership companies as "no deadhead costs," their misrepresentation of some of the costs of full ownership, and the insincere approaches made to many flight departments under the guise of "supporting their operations" when their real intent is to replace those flight departments in their entirety, make an otherwise useful addition to the spectrum of aviation services take on a rather schlockish nature reminiscent of "junk bond" salesmen.

Fractional ownership can be a good thing. But it requires honesty in the presentation of the real costs involved and ethical behavior by the salesmen representing shared ownership companies that has been sadly lacking with some of the independents.

Fractional ownership companies offer a wide range of models giving users the ability to match an aircraft to their pocketbooks.

How fractional ownership works

Fractional owners pay a proportionate part of the list price for an aircraft, typically one quarter share, and then pay the fractional ownership company a fee for each occupied flight hour and an overall fixed management fee which covers deadhead, maintenance, and administration of the program. Customers seldom, if ever, fly in the actual aircraft in which they have purchased a fractional share. And, due to the large number of aircraft and diversity of destinations of some fractional ownership operations, they seldom fly with the same crew.

Some examples of typical purchase prices, management fees, and hourly costs offered by fractional ownership companies for various aircraft are shown in Figure 1. The fractional ownership share acquisition price is typically one quarter of the then current full manufacturer's advertised list price for the chosen aircraft. As can be seen, the fixed management fees and hourly operating costs are not cheap by any means. But how do they compare with out-right aircraft ownership using a conventional flight department?

To perform such an analysis, we have to spend a few minutes familiarizing ourselves with the way aircraft costs are measured. The approaches described below are standard methods used by aircraft manufacturer's in presenting their products to customers, CFOs of aircraft users in evaluating aircraft purchases, and various information providers such as Conklin & de Decker. Of course, certain elements of the cost analysis will vary from company to company, such as the interest rate used for financing the purchase of an aircraft, fuel and hangar costs, or the exact tax rate assumed by the user. But, generally, the method of establishing costs presented in the following material is widely accepted and used in the industry.

Measuring aircraft total ownership costs

Aircraft ownership and operating costs can be divided into four general categories: Acquisition and Capital Costs; Direct Operating Costs which includes things like fuel and maintenance; Indirect Operating Costs which include insurance, hangar rent, pilot salaries and benefits, and recurrent training; and Other Deductible Expenses such as interest expense and aircraft depreciation for tax purposes which can be deducted from a company's income tax burden and hence help to offset the cost of ownership of the aircraft. A typical cash flow projection is shown in Table 1 for the Hawker 800XP, a popular model with both corporate flight departments and fractional ownership companies.

Many people when evaluating the cost of ownership of an aircraft look only at the Direct Operating Costs, Indirect Operating Costs, and Deductible Expenses such as interest expense and depreciation for tax purposes. This can lead to a very inaccurate view of the true total cost of ownership of an aircraft since it overlooks the single greatest cost of all: the loss in the market value of the aircraft with age and use.

The tax laws allow us to recover some of the loss in value of an aircraft but certainly not all. A company can depreciate its aircraft under accelerated depreciation over a 5-year period. The most frequently used method is MACRS, with half-year convention and 5 year recovery. If we assume a company's federal tax rate is 35%, then the effect of depreciating the aircraft for tax purposes would allow us to recover 35% of the original purchase price of the aircraft in five years through reductions in the amount of Federal Income Tax the company would have otherwise had to pay without the benefit of depreciating the aircraft. Of course this only applies if the company has enough income to be able to use the full amount of the depreciation to offset a portion or all of its taxes.

This works fine as long as the real loss in market value of the aircraft has not exceeded the 35% we have been able to recover under federal income tax. But what if the real market value of the aircraft has decreased by more than 35%? Well, Uncle Sam is not very concerned and doesn't "feel your pain" in this case. A company experiencing a loss in value greater than 35% simply loses the additional money. The very important point to realize is that this loss in real market value beyond 35% is a very real cost of ownership of the aircraft and should be considered in any aircraft cost analysis for any aircraft that is likely to lose more than 35% of its value in five years.

A typical cash flow analysis for full aircraft ownership as might be supplied by an aircraft manufacturer as adapted from a Raytheon Aircraft cashflow study.

There are other concerns as well when considering the effects of an aircraft's loss of market value. Most operators eventually want to trade their aircraft in on a replacement or larger model sometime within the first five years. The average runs about four years. At that time, the company frequently trades in the older aircraft on a new one. The trade-in value of the used aircraft becomes very important since it is the difference between the new aircraft cost and the trade-in value of the older aircraft that determines how much money a company has to come up with to buy the new aircraft. If an aircraft has lost a lot of value with use over the four or five year period of ownership, then the buyer is going to have to come up with a lot more money to buy a new aircraft. Alternatively, if the used aircraft has lost little value, then the buyer will need to come up with less money to cover the new purchase.

When evaluating aircraft costs, it is extremely important to recognize this loss of value which has resulted in our having to pay a higher out-of-pocket cost for a new aircraft, as a real cost of ownership of the aircraft being traded in. Many operators fail to consider this very important cost and surprisingly it often exceeds the entire cost of operation ­ both direct and indirect ­ of the older aircraft for the entire period of ownership. In fact, with most aircraft, the loss in real market value with age and use is the single greatest cost in operation and ownership of an aircraft.

Now, as we all know, there is no free lunch with the IRS, and the beneficial effects of an aircraft that has held its value exceptionally well during its four or five years of use, is accounted for by establishing the basis for depreciation on the new aircraft as the difference in the purchase price of the new aircraft and the net sales price of the trade-in aircraft (assuming it has been depreciated to zero value for tax purposes). Hence, our available depreciation on the new aircraft is reduced. But the important point to realize here is that the effects of the reduced base for depreciation is spread out over the next five years and additionally we don't have to come up with as much cash to purchase the new aircraft.

Clearly, any purchaser of an aircraft that is in any way concerned about its cost of operation and ownership should pay a great deal of attention to how that particular model of aircraft, and the way it is used, effects its loss in real market value with use and age. When this factor is included in the cost equation, this "total cost of ownership" is the real cost of owning and operating an aircraft as shown in Table 2 for the Hawker 800XP.

Some aircraft models hold their value better than others do. In general, jets hold their value much better than turboprops, for example. And very importantly, as we shall see later, aircraft that are employed in commercial operations for hire and which are flown a high number of hours each year, tend to loose market value far more rapidly than aircraft flying typical corporate profiles of 500-800 hrs a year in private service.

Cost often overlooked

Herein lies one of the great misunderstandings about the costs of fractional ownership. A company buys a fractional share and gets to depreciate it for tax purposes at the same rate as a full owner. But while the fractional share owner is only flying 200 hrs a year, the loss in the market value of his asset ­ the quarter share ­ is occurring at a rate typical of a commercially operated aircraft for hire flying 1500 to 2000 hrs per year!

Remember, even for the full aircraft owner, the greatest single cost of aircraft ownership is the loss in the market value of the aircraft with age and use. Whereas the rate of loss in market value for a typically flown corporate aircraft is on the order of 5% per year for the first five years and about 2% per year thereafter, the rate of loss in market value of fractional ownership airplanes runs at more than double that rate due to its much higher usage levels and commercial operation; perhaps as much as triple. Doubling or tripling your single highest cost in the ownership and operation of an aircraft is not a way to achieve high economy in your aviation operation. Of course, no fractional ownership company is going to point this out for you.

Don't be misled by some fractional ownership companies assurances that you will get "fair market value" for your fractional share when you decide to leave the program or move to a larger model. There is nothing "fair" about it. Your share's market value is going to have depreciated at a rate two to three times that of a typical corporate aircraft even though you used it only 1/4th as much.

Some typical cost examples

So, how do all of these cost considerations effect our purchase decisions on new aircraft and particularly, how do they effect a decision between fractional ownership and full aircraft ownership based on costs?

Tables 1 and 2 show the cost of ownership of a fully owned Hawker 800XP operating 444 hrs per year with 10% deadhead, resulting in 400 occupied hrs per year. Tables 3 and 4 show the cost of ownership of a half share of a Hawker 800XP operated 400 hrs per year with passengers on board.

Some important differences between the two cases should be noted: In the case of the fractional share, the owner pays one half the full manufacturer's list price for the aircraft but the corporate purchaser gets a 3% to 4% discount (typically) on his purchase of the full aircraft. Deadhead time for the fully owned aircraft is 10% of total hours flown, not the 30% suggested by some fractional ownership companies in their misleading sales presentations. A 10% deadhead time allotment is typical for well run corporate flight departments across the nation; many corporate flight departments do better than this with careful planning.

Since fractional ownership deadhead costs are buried in the monthly management fee, no time allowance is provided for them in this analysis. Fractional ownership aircraft deadhead does run as high as 33% and, I suspect in some cases, higher. These costs, which are spread across the entire base of fractional owners, are certainly not free and are allocated according to one's share size, and not according to actual use. Hence, if your primary flight profile is out and return, under fractional ownership you will be paying a lot for the high deadhead time levels characteristic of any fractional program but which would not be required if you were operating your own fully owned aircraft.

For the purposes of this analysis, I have assumed the fractional share will only depreciate at 10% per year although I believe it could be substantially higher due to the large number of hours flown per year as a commercial operation. Hence we have at least doubled our single greatest cost of operation and ownership: the loss in the aircraft's market value with age and use. Add to that the hefty monthly management fee and the imbedded cost of high deadhead hours characteristic of fractional operations and the cost of the fractional ownership aircraft quickly surpasses that of the fully owned aircraft.

In fact as the examples shown in Tables 1-4 indicate, the true total cost of operation of a fractional ownership aircraft operated 400 hrs a year is almost double that of a fully owned aircraft staffed with a conventional flight department when all of the costs are considered.

How can this be so? Well firstly, notice that the greater loss in value of the aircraft accounts for almost all of the increase in cost of a fractionally owned aircraft compared to a fully owned aircraft. But this is not surprising when you consider these fractionally owned aircraft are being operated in a commercial, for hire service and are being operated two to three times the number of hours per year as a normal corporate aircraft. This tremendously effects the resale value of the aircraft. Also, with so many fractionally owned aircraft having been purchased, there will come a day when these flood the used market, further driving down resale values.

Direct operating costs and indirect operating cost equate to a fractional company's hourly cost and management fee.

Clearly, fractional ownership does not make economic sense for the typical corporate flight operation. Where it does make sense is for users with extremely low flight time requirements; and there are plenty of those. The break-even point between the costs of full ownership and fractional ownership occurs some where between 100 and 200 hrs per year. If you are flying more than this, full aircraft ownership is less expensive. But charter offers a viable alternative to fractional ownership in these hour ranges as well and any company considering buying a fractional ownership aircraft for flight times less than 200 hrs a year should investigate the charter option as well.

Given these facts, is there any way that fractional ownership can be made more cost efficient than at present? Yes, there is, and it involves attacking the biggest cost element in the total cost equation: the rate of loss in the market value of a fractionally owned aircraft.

Business aircraft experience their greatest rate of loss in market value during the first five years of ownership. After the first five years, the rate drops to less than half of the value experienced in the first five years. Typically, corporate aircraft six to 10 years old lose value at a rate of about 2% per year. If fractional ownership companies based their operations around outstanding used aircraft, suitably refurbished so they could not be distinguished from new aircraft, then the high rate of loss in value could probably be cut in half. This could make fractional ownership practical for users requiring as high as 200 to 400 hrs per year of flight time and would greatly reduce the costs for the 100 to 200 hr users as well.

Also, limiting the number of users per aircraft by not selling less than a quarter share will substantially reduce deadhead time and charter costs when there are unresolved scheduling conflicts which occur more often with more owners per aircraft.

But to be successful, fractional ownership companies basing their fleet around used aircraft need to follow many of the same principles established by conventional fractional ownership companies. They need to operate a common fleet of aircraft where each aircraft is the same model and has been equipped similarly with identical interiors and exteriors. Also, the choice of used aircraft model is important and should focus on those aircraft with a reputation for longevity and reasonable maintenance costs at their six to 10-year age level. Some examples that come to mind are the Falcon 50 and the Falcon 900 or the GIV.

There are several fractional ownership companies pursuing this approach: Flight Options and a new startup called First Flight which is a spin off of Airborne Inc, a successful aircraft management company out of Elmyra NY. These companies have great promise in bringing the costs of fractional ownership down to more reasonable levels.

Roy Norris views the GA industry from Savannah, Georgia where he runs the Norris Group, Inc (www.norrisgroup. org). He has spent 20 years in GA serving as president of Raytheon Aircraft and senior VP marketing and sales for both Cessna and Gulfstream Aerospace. Norris has also been responsible for the introduction of more than 10 new business jet aircraft models during his career.

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