As published in Business Air Magazine
Everyone is talking about the new “normal” in aircraft residual values. The first question might be to define what is “normal”. Most often the comment about normal is referenced by the term “historical normal”. What period are we talking about? Obviously, the last 10 years the historic normal is much different than the previous 10 years.
It is our belief that a misconception on residual values has been related to inflation. Residual values are primarily driven by a demand/supply equation. However, we believe that a secondary driver that can alter the perception of value expectations is the inflation rate. If you have been in the business as long as I have, you can remember the guy buying a plane for $2.0M and 17-18 years later selling it for nearly the same amount. Boy, a plane is a great investment. But, the real value adjusted for inflation shows a different story. And it is a story that needs consideration.
A couple of years back, a very popular price index book used a plane that had a value of $3.7M new in 1978 and now was selling for 12% of new at $450,000. It doesn’t sound too bad until you factor in the inflation adjustment since 1978. After adjusting for inflation the real resale percentage is 3.3% of new! Using another example, a 2000 G lV in 2005 sold for 77.5% of new, however, adjusting for inflation it was really selling for 68.8% of new.
Looking at the history of inflation rates, from 1996 to 2006 inflation went up 28.5% or on average 2.85% per year. 2006 to 2016 the rate was 18.7%, or 1.87% per year. And finally looking at 2009 to 2016 only 11.5% or 1.43% per year. (2014 to 2015 the rate was slightly negative.) In the last 14 years, the rate of inflation for the first 7 of those years was just over twice what it has been in the last 7 years.
Without any supply/demand issues in the equation, a person with a frame of reference for resale values based on 1996 to 2006 would see a reduction in value expectations of about 10% from 2006 to the first quarter of 2016. This expectation is based solely on not considering the inflation adjustment when considering residual value percentages.
When I was an economic major in college, the inflation rate was in the low to mid teens. Nixon put price controls on trying to break the cycle of inflation and there were many other ideas to fix the inflation rate. Inflation was the enemy. However, the inflation enemy wasn’t the same for everyone. I remember an economics professor stating “be careful of assumptions that inflation is bad for everyone.” In fact, a little inflation can be good for some people. People with a fixed rate mortgage are one example where inflation is good. On the other hand, it is bad for people on non-inflation adjusted fixed incomes.
Perhaps a good economy will result in a more ”normal” inflation rate and thus a trend towards inflation adjusted historic normal residual values. Perception is a critical component of buying and selling behavior. I think psychologically, most owners would like to see a 10% increase in their projected residual value.
Hawkeye Aircraft Acquisitions