Fractional ownership is on the rise, so power up that corporate jet
Despite the fact that President Obama has started taking aim at tax breaks, fractional ownership is gaining steam post-financial crisis, offering affluent consumers an efficient use of their dollars and time. So if you thought owning a piece of a private jet or Italian villa was just for the Cannes crowd, think again.
Private aviation, in particular, has taken a tongue lashing as of late, thanks to Obama’s proposal to augment tax breaks for corporate jet owners in an effort to fill the country’s coffers.
At issue is a proposed extension of asset depreciation time lines for corporate jets, which would see the expense written off over seven years, as opposed to the current five years, and will likely funnel an extra $3 billion back into the cash-strapped Treasury over the next decade.
To partially repeal the obscure advantage over commercial aviation will do nothing to deter corporate jet business, says Walter Stewart, chairman of the Stewart Organization. Stewart’s company owns 40 fractional shares in two Learjets and a Challenger 300, while Stewart personally holds a share in a Challenger 300 jet with private aviation company Flexjet.
“What they’re proposing to do is simply change the depreciation method of the airplane. Overall, it will have a tiny affect and will certainly not be a consideration for us at all,” he says. Private aviation is integral to his company’s operations, Stewart says, adding the use of a private jet has been “a game changer.”
“I’ve gotten old enough that my time is the most important thing to me. I couldn’t do everything that I do at my age and do it with commercial aviation,” he says.
Despite the political posturing, Fred Reid, president of Flexjet, says the private aviation industry will continue to grow. New business for Flexjet — which offers whole aircraft ownership, fractional ownership and charter flights — is 45 percent higher than in 2009 with the first quarter of this year up 64 percent over the same period last year.
“We have owners who have 14 factories, 180 restaurants, 90 retail outlets and they get a huge advantage if they can fly to these locations in a day, be home to sleep in their own bed and have a board meeting the next morning. That would have taken two to six days commercially,” Reid says.
In the real estate industry, fractional ownership totaled $530 million in 2010, according to a report published by real estate consultants Ragatz Associates. This represents a substantial drop from the 2007 peak of $2.3 billion; however, 71 percent of resorts report sales had either been steady or increased in the second half of last year.
How fractional ownership works
Investors can generally go one of two ways to structure fractional ownership: purchase assets through a company that specializes in fractional ownership or strike an independent partnership with other affluent players looking to invest in a high-value, low-use asset.
Real estate is by far the largest sector in the fractional ownership sphere, says George Sell, editor of fractionallife.com, a UK-based website dedicated to the fractional ownership marketplace. “People who buy a second home for vacation generally only use it for three or four weeks a year. The rest of the time it’s sitting empty or they have to pay a management company to handle rentals and maintenance,” says Sell. “If you want to spend $200,000 on a holiday home you, could spend that on a fractional ownership property and buy into a $2.5-million property for the equivalent price.”
Investors purchase a piece or percentage of a property, as opposed to a timeshare where customers pay for the right to use a property for a certain amount of time. Fraction sizes generally range from 1/6 to 1/12 of a property. “With most fractionals these days, you get a percentage of the deed. In that respect, it’s the same as normal real estate in that you can sell it, pass it on to your family or leave it to someone in your will,” says Sell.
Private residence clubs represent the high end of the market. Share prices range from $200,000 up to $3 million for a 1/8th share with median prices hovering in the range of $350,000 to $500,000.
Fractional ownership in private aviation works slightly differently in that ownership emulates a membership club, offering access to a large fleet. Owners can purchase shares starting at 1/16 of an aircraft (about 50 flying hours per year) under a typical five-year contract. Depending on the deal, fractional owners may sell their stake or can exercise a put option, which the company will honor at fair market value, when the contract expires.
Whether buying a private aviation membership or splitting the costs of a 3,365-squre-foot vacation home complete with private putting greens, purchasing a luxury asset fractionally can be a complicated process. Here are a few things to consider:
Know what level of hassle you want to endure
If you invest with a company that caters to fractional ownership, you’ll pay more in the form of managerial fees, but will avoid many of the logistical headaches that can com e when you make arrangements on your own with a group of well-heeled investors.
“The record keeping has to be someone’s headache, someone has to agree to that — either a diligent partner or a CPA bookkeeping service or someone’s family office representative. If you don’t, it’s a nightmare on Elm Street waiting to happen,” says Eric Johnson, principal and senior client strategist at Signature, an independent wealth management firm.
With a company like NetJets or Flexjet — all the nitty-gritty hassles are taken care of. “We handle all the details from aircraft maintenance, pilot training, arranging the flight, catering, ground transportation and all the logistics around that. You literally make a phone call and it’s handled,” says Adam Johnson, president of sales, marketing and service at NetJets North America. “If you have your own aircraft, you’re in the business of aircraft management and all those issues become your responsibility and your hassle.”
With access to a large fleet, scheduling during peak times also becomes easier. “You have to work out who gets [the aircraft] on Thanksgiving, who gets it on Christmas and who gets it for the next golf tournament. With us, you don’t have to worry about that,” says Reid.
Know what you can afford
Uneven financial constraints can fray a fractional agreement, which can be further exacerbated by unforeseen financial circumstances. Annual costs of a luxury asset tend to surprise on the upside as management fees, maintenance costs, legal expenditures and membership charges come into play. “For someone with a $50 million capital expenditure, it might be nothing but for someone with a $7 million net worth, that annual expenditure assessment might be significant,” says Signature’s Johnson of his wealth management clients.
If pursuing ownership through a company, costs should be spelled out in black and white. For example, investors in the NetJets share program purchase an undivided interest in a specific serial aircraft, which is directly proportional to the number of hours you fly in a year. Costs are guaranteed and predictable for a typical five-year term, says Johnson of NetJets. “If you own your own aircraft and you have a major mechanical issue that needs to be addressed, those costs are upfront. With a fractional program, it’s predictable. You know exactly what your cost structure is going to be,” he says.
Informal arrangements tend to be trickier. Be honest with yourself and your potential partners, Signature’s Johnson recommends. “Having financial forecasts and strong estimates upfront are one thing, but investors, in my opinion, need to have a very frank discussion that there will be substantial capital costs and is this something you’ll be able to bear?”
Know your withdrawal options
Regardless of how excited you are about your new Hatteras yacht, there may come a day when you want out of the deal, so don’t ignore the importance of liquidity options. Established aviation and vacation-property companies will likely offer withdrawal plans depending on your agreement. With Flexjet, fractional owners typically purchase a five-year deal with the option to exit at any time. If not satisfied within the first 90 days, or after three years of ownership, clients can withdraw penalty free.
Things become decidedly more complicated when looking to withdraw from an independent arrangement. If one owner decides to depart, typically those assets are offered to the remainder of investors, says Johnson of Signature, which would mean increased ownership with increased usage time. Or, owners can bring in another interested party to purchase the fraction of assets up for sale.
“The problem is if someone withdrawals and they made an initial investment of $1 million in a $5 million project and now it’s worth $720,000. I have to bear that cost if I’m departing. If everyone agrees and says this isn’t working and it was the worst investment that you all made, than you would potentially put it on the market,” says Johnson.
Spell out liquidity options with all partners before signing on the dotted line. “Like any other purchase of this type, you have to be careful and do your homework. Get everything checked out by your lawyer before you sign anything,” recommends Sell.
“It’s not for everybody but it makes sense for an affluent consumer who is looking to use disposable income more sensibly. You can get a really good lifestyle experience from it for considerably less cash.”