Guidebook for Developing and Leasing Airport Property (2011)

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10 While a lease is often considered a complex and daunting document by the legal and real estate neophyte, it can be easily understood and digested if the individual components that comprise the whole are broken down and examined in detail. Every lease, regardless of type, is comprised of essen- tially the same core elements; understanding the individual components of a lease will provide the necessary building blocks needed to construct and execute a successful airport lease agreement. The first section will address the basic types of leases at an airport and the core elements included in each. The type of airport lease applicable to each agreement will vary based upon the tenant and anticipated use of the land or facility (i.e., private versus commercial venture). These general lease types can be broken down into the following broad categories: • Aeronautical versus nonaeronautical leases, • Land leases, • Fixed-base operator (FBO) leases, • Specialized aeronautical service operator (SASO) leases, • Hangar rental leases, • Subleases, and • Airline leases. Subsequent sections in this chapter will list and detail the core and optional lease elements that comprise a complete lease agreement. How these elements fit into the overall lease, the key con- siderations of each, and their potential impact on the airport sponsor and tenant are examined. 2.1 Airport Lease Types There are various lease agreements, each with unique characteristics, which are in effect at any given airport. The variance between lease structures is dependent upon the type of tenant (i.e., commercial versus private individual), the location of the leasehold (i.e., airside versus landside), and the type of activity to take place within the leasehold. The structure of the lease, as indicated by the lease elements included in the agreement (discussed later in this chapter), should always reflect the activity, tenant type, and location of the leasehold in order to protect the financial, development, and regulatory needs of the airport. The following sections will present an overview of the characteristics of differing lease types, and the considerations an airport sponsor should take into account before executing a lease agreement. 2.1.1 Aeronautical Versus Nonaeronautical Many airports have aeronautical, or aviation-related tenants, users, and lessees, and nonaero- nautical tenants who lease property from the airport but do not necessarily depend on, nor C H A P T E R 2 Anatomy of a Lease

require, the airport itself for the fulfillment of their business activities. This Guidebook focuses primarily on aeronautical activity, which is most consistent with the core mission of the airport sponsor. However, nonaeronautical airport development is often an important component of the business mix, providing nonaeronautical or nontraditional revenue streams that can help sustain the operating requirements of the public airport. The airport sponsor often welcomes nonaeronautical uses (e.g., cases where the airport has excess property as the result of buffers put in place to ensure compatible development; the acqui- sition of property under a noise mitigation program; or public benefit transfer of former military air bases that required a larger land footprint than the public airport). In such instances where the airport sponsor has excess property that is not required for aeronautical use, the FAA is gen- erally supportive of nonaeronautical uses on airport property. Such support typically requires that the airport sponsor receives fair market value for the land, and the nonaeronautical use does not preclude or retard the aeronautical development of airport lands as demand for aeronautical property occurs. To achieve this balance of aeronautical and nonaeronautical uses, it is important to put qual- ity planning tools in place. The central consideration is to determine when the property will be needed for aeronautical purposes. If good forecasting and planning tools are employed and property is not foreseen to be needed for aeronautical purposes for an extended period of time (e.g., 50 years), the airport sponsor may justifiably pursue nonaeronautical development on that property. Property furthest from airfield infrastructure may have greater potential for nonaero- nautical development than property closer to aeronautical surfaces that may have forecasted aeronautical needs in the next 10 to 20 years. In this example, the airport sponsor would be wise to refrain from considering new nonaeronautical development on the property that is forecast to be needed for aeronautical development in as soon as 10 years; new development is likely to require a land lease that would extend beyond 20 years. For this reason, the property furthest from airfield infrastructure may actually have a higher value for nonaeronautical development and should be considered first. The key is that nonaeronautical development is an important tool for the airport sponsor to employ, but it should be carefully balanced with the core mission of the airport sponsor in devel- oping airport land for aeronautical purposes. 2.1.2 Land Lease With the possible exception of terminal leases at commercial service airports, land leases are the most common type of airport lease. A land lease is simply an agreement whereby the airport spon- sor leases a parcel of land for a stated period of time (term) and the tenant, or the tenant’s devel- oper, is responsible for making improvements on that land. Long-term leases of land are most commonly used for the purpose of erecting buildings and/or making improvements. At the end of the lease term, the land and all structures and enhancements will typically revert to the owner. Land leases should follow the basic format of facility leases and include all of the same references to the Airport Rules and Regulations, and Airport Minimum Standards discussed in Chapter 3. The land lease price per square foot (rent) may vary by location on the airport and possibly by the length of the term. The value of a land lease is also dependent on permitted uses. The site for an FBO, for example, will likely have a greater value than the site for privately-owned aircraft storage hangars because the revenue generation potential is typically much higher on the site where FBO activities are permitted. Depending upon the type of tenant, facility, and anticipated activity that will take place on the leased land, differing elements and stipulations may need to be included in the lease agreement. Leases for commercial operations may include elements beyond typical core lease elements that Anatomy of a Lease 11

are addressed in a standard airport lease policy. These considerations may include stringent insurance requirements, limitations on the types of activity that can take place, revenue sharing agreements, and minimum levels of ser- vice that must be offered. These elements are addressed in greater detail in the subsequent lease elements section of this chapter. 2.1.3 FBO Lease At most airports, FBO leases represent an area of significant interest and rea- sonable complexity involving the assembly of exclusive and nonexclusive as well as public and private attributes. The majority of general aviation airports require an FBO to provide a variety of services that are identified in advance by the airport sponsor, typically through a Minimum Standards document. In return for providing this full complement of identified services, the FBO is granted the ability to sell fuel. Fuel sales are typically a significant component of an FBO’s business model and income. Additional services an FBO might provide include, but are not limited to, aircraft storage, ground handling, maintenance and repair, flight instruction, aircraft rental, and aircraft sales. Because the FBO serves as a quasi-public portal to the community, often adjacent to a public ramp, and often tasked with collecting fees on behalf of the airport, FBO leases typically contain as much airport-use agreement ter- minology as commercial real estate language. The added complexity of an FBO lease dictates that FBO leases be negotiated individually based upon the FBO service levels desired by the airport sponsor and the ability of the FBO to profitably provide said services. Despite the additional complexity, FBO leases should still follow the basic format of a standard airport facility lease and include all of the same references to the Airport Rules and Regulations and Minimum Standards documents. 2.1.4 SASO Lease While an FBO provides fueling service and engages in one or more aviation- related services, a SASO provides specialized products and services in one or more of the aviation-related service areas such as flight training or mainte- nance, excluding the retail sale of fuel. A SASO may operate under a direct lease agreement with the airport or as subtenant of an FBO. A corporate hangar lease may constitute a SASO lease since its underlying purpose is a com- mercial enterprise whereby in-house maintenance and fueling activity may be taking place. The lease agreement may allow for these functions taking place in-house but limit these operations to based aircraft only (i.e., no servicing of transient or third-party aircraft) in order to financially protect other on-airport FBO and SASO operators. 2.1.5 Hangar Rental Agreement A hangar lease is typically flexible enough to accommodate all hangar types, sizes, and tenants, from small T-hangars to large conventional hangars. The variable in these leases is usually the rental price. The rental price of the building may vary based on size, amenities, location, access, and condition or type of door-operating mechanism. It is not uncommon for the same size hangar to have different prices based on amenities. This type of lease generally specifies that hangars are for aircraft storage only. Hangars leased for a business purpose should be covered under an FBO 12 Guidebook for Developing and Leasing Airport Property For business and recreational gen- eral aviation travelers, the FBO will provide the first impression of an airport and its community. The quality of the FBO’s facilities, ser- vices, and aesthetics is critical in making that positive first impres- sion. Realizing that their existing FBO was somewhat lacking in this area, Coastal Carolina Regional Airport partnered with the airport’s existing FBO and local business leaders to construct a new FBO that would convey a positive image of the airport and community to travelers. In order to achieve this goal, the lease needed to be struc- tured in a way that would allow the FBO to recoup its investment in the construction of the new facility. With assistance from the state, the airport completed the ground improvements for the facility and transferred the lease terms from the outdated facility to the new facility. This lease consideration, in conjunction with state funds and donations of equipment and supplies by the local business community, made the new FBO financially feasible for its operator.

or SASO lease. Storage hangar leases generally prevent a tenant from using the property for con- ducting a business or for storing other items because aircraft storage hangars typically do not have safety or public amenity attributes required for a proper business venture. The lease should require compliance with Airport Rules and Regulations and Minimum Standards and is generally short in term length to allow for market adjustments in rent. 2.1.6 Sublease (Subletting) Many agreements include language governing the tenant’s ability to sublease (sublet) all, or a portion of, the leased property at the airport sponsor’s discretion. Typically, the sublease is for a defined portion of the improvements: space in a conventional hangar, office space in an FBO building, or warehouse space and truck docks in a cargo building, for example. The ability and extent to which an airport tenant can sublease a facility must be clearly stated in the primary lease document between the airport sponsor and tenant. Depending on the type and function of the facility, the airport may require a formal approval process for any potential subtenants, a process that mandates the primary tenant submit written notification of the lessee’s intent to sublease a portion of a facility. The submission should provide the following information to the airport: • Location and size of the proposed sublease, • Description of proposed use, • Sublessee organization and authorized users, and • Terms of the proposed sublease agreement. It is the responsibility of both the airport and primary tenant to ensure that any sublease agreements conform to Airport Minimum Standards policy. The airport has the role of ensuring compliance with policy in its dealing with the primary tenant, as specified in the lease agreement. However, the oversight of sublease compliance can fall equally to both the airport and primary lessee. Since real estate values typically appreciate over time, it is not uncommon for the lessee to have a net profit when subletting space. In cases where the ten- ant pays a known amount for space and sublets for a greater amount, it’s not uncommon for the airport sponsor in a commercial leasing scenario to receive a percentage of the profit. Detailed provisions should be spelled out in the lease and any operating agreement to avoid future conflict between the parties in a long-term lease agreement. 2.1.7 Airline Leases Airline leases, as one might imagine, are prevalent at many airports and take on a variety of forms. Lease agreements (also referred to as operating permits, use agreements, or licenses in some circumstances) will reflect the financial policy and rate-setting methodology of the airport. An airport’s rate- setting policy/methodology will consider the various types of spaces that an airline will need to lease, how rental rates are calculated, and the allocation of costs associated with operating those spaces. Airlines traditionally lease their core operating spaces, such as ticket coun- ters, boarding gates, and office/operations areas, on an exclusive or preferential basis, ensuring that they have the facilities necessary to meet the operational needs of their flight schedule. Other spaces, such as baggage claim and bag- gage make-up areas, are routinely leased on a joint or common use basis. Com- mon use facilities, however, are becoming more widespread. An airline may consider leasing boarding gates and even ticket counter spaces in a shared Anatomy of a Lease 13 When George Bush Intercontinental/ Houston Airport constructed its consolidated rental car facility (CRCF), it was anticipated that there would be nine rental car operators that would use the facil- ity. Rather than negotiate and deal with nine separate lessees, the air- port required the consortium of operators to form a limited liability corporation (LLC) with which the airport would enter into the lease agreement. Operators pay the LLC for operational expenses based upon their use of the facility. The LLC, in turn, is responsible for maintaining and operating the CRCF, including bus operations between the facility and the air- port, utilities, and insurance. This is essentially a sublease arrangement by the LLC with the members of the consortium that constitute the LLC. Due to this arrangement, the airport has only a single entity to deal with and is able to shift much of the administrative, operational, and financial burden of the facility to the LLC.

arrangement, especially in situations where they have a limited number of flights and cannot jus- tify the cost of leasing on an exclusive or preferential basis. Airlines just entering a market with a reduced schedule or international carriers that offer reduced frequency are examples of when common use applications might be desirable. Aside from passenger terminals, an airline may be one of several tenants in other multitenant facilities such as cargo buildings or ground support equipment buildings. In the passenger ter- minal scenario, the airline lease should address the allocation of terminal space costs that are not directly leased to the airline, such as mechanical and utility rooms, and public areas such as ticketing lobbies, restrooms, and hallways. In the instance of a multitenant facility other than a passenger terminal, attention should be given to shared interior spaces such as vestibules and access hallways, and shared exterior facilities such as automobile parking and airside access. Allo- cation of these common area costs should always meet the unique attributes and needs of a given situation and be equitable to the parties affected. Allocation of these costs should be addressed within the rate-setting methodology. Even within a multitenant facility, such as in the case of a passenger terminal environment, an airline may lease several different areas and/or types of facilities. For example, the airline may rent ticket counter and office space in the ticketing area of the terminal, which likely has a different rental rate associated with it than baggage make-up areas and operational spaces. In the gate area, the airline may have yet another arrangement for gate podiums and/or the use of passenger board- ing bridges that have their own unique set of rates and charges. Two rate-setting philosophies are prevalent within the industry. The compensatory model is an approach that gives the airport sponsor autonomy in setting its fees and charges. Compen- satory terminal rents may be calculated on the gross terminal space minus mechanical spaces, or the total rentable space within the terminal, to include airline spaces. It may be based on some other variation, but the compensatory model typically allows the airport to retain rev- enues that exceed expenses. This model also places the burden of any revenue shortfall on the airport sponsor. The second model is the residual model (sometimes referred to as the cost approach), which routinely includes a majority-in-interest airline’s review of the forecast costs to be considered in the rate-setting exercise and generally places the airport sponsor in a revenue neutral position. Because the residual approach tends to focus on a break-even scenario, with appropriate reserves, both excesses and deficiencies in revenue collection generally carry from one year to the next. The cash position of the airport may, therefore, be limited in this model. Table 1 contrasts the two rate-setting approaches and highlights the attributes of each. An airport may choose to employ a hybrid of these two approaches, as well. For example, a residual approach might be applied to airfield costs in the calculation of landing fees, while a compensatory approach might be used in setting terminal rents; or a compensatory approach may be chosen for the entire airport, with credits given for certain revenue such as terminal con- cessions to help reduce airline costs. Hybrid approaches are limited only by the imagination; the rate-setting approach, whether it’s compensatory, residual, or a hybrid thereof should ultimately meet the needs and goals of a specific airport and its unique mix of airlines and tenants. Landing fees and fuel flowage fees within an airport’s schedule of rates and charges also play a role in airline leases and use agreements. The matrix of fees that an airline pays at any given airport can be quite complex and cover a broad range of real estate types. Ultimately, one of the metrics an airline uses to measure an airport is the total cost, per passenger, that the airline must pay in rents, fees, and charges to do business. This is then compared against other airports of similar size and against the market yield the airline is able to obtain. 14 Guidebook for Developing and Leasing Airport Property

An airline may also occupy single-use airport developments that have the same lease attributes as any other single-tenant facility. This is especially true at airports where the airline has the level of activity and presence to support a stand-alone airport development such as a maintenance operation or its own cargo facility. While neither airline use agreements nor rate-setting methodologies are the subject of this Guidebook, they both represent a component of the complex issue of airline compensation to the airport sponsor, and correlate directly to the subject of leasing and developing airport property. Ultimately, airline leases represent one small piece of this complex puzzle and contain many of the same elements as any other airport lease. For a more comprehensive discussion of this subject, the reader is encouraged to review ACRP Report 36: Airport/Airline Agreements—Practices and Characteristics. 2.2 Essential Lease Elements Through the case study interviews, the intangible effects of relatively good and relatively bad agreements were revealed. It became readily apparent that agreements tend to either set the stage for a mutually beneficial long-term business relationship that will withstand changes in staff, own- ership, and tenant management—or set the stage for dispute. Ambiguity in the lease agreements Anatomy of a Lease 15 Table 1. Rate-setting models: compensatory versus residual. Compensatory Model Residual Model Typical Application Airports with positive cash flow and relatively high levels of liquidity/discretionary cash on hand or airports that require subsidy from an outside agency Airports with consistent levels of operations and who are willing to trade cash-on-hand to reduce the fees and charges that airlines must pay Party That Assumes the Majority of the Financial Risk Airport—the airport sponsor bears the short-term financial risk and is more exposed to financial and economic downturns. Airline—the airport sponsor recovers “net costs” of the airport's operations through fees and charges paid by the airlines. Advantages (from airport sponsor’s perspective) The airport sponsor retains all of the benefits derived from nonaeronautical revenues and airlines receive no direct benefit from this revenue source (thereby incentivizing the airport to pursue nonaviation revenue). The airlines have limited control over capital projects, and the airport sponsor has the ability to maintain relatively stronger operating and debt coverage ratios. The airlines guarantee the financial soundness of the airport and share in the risk of financial and economic downturns. Disadvantages (from airport sponsor’s perspective) The airline pays only for the facilities it uses and does not take part in sharing all of the airline-related costs of the airport. Nonaeronautical revenues are credited toward the airline's rate base and the airlines pay fees and charges based on net costs after nonaeronautical revenues are subtracted. The airport sponsor has less incentive to maximize nonaeronautical revenues, and the airport generally has less liquidity/discretionary cash, which can result in a weaker balance sheet and a higher cost of capital.

themselves seems to be a common culprit or contributing factor when disputes arise. The most successful lease agreements leave few open issues to dispute or misinterpret. The following sections provide an overview of the core elements that must be included in a lease to ensure that all parties are in agreement and have the same understanding of the contract into which they are entering. 2.2.1 Lessor The lessor is the owner of a property that is being leased. In other words, the lessor is the land- lord. In the case of airport leases, the lessor is the airport sponsor or controlling agency with authority to enter into contractual agreements on behalf of the airport sponsor. For any lease agreement, the lease document must contain the names, addresses, and signatures of all parties involved in the agreement and, more specifically, the individuals authorized to execute agreements and obligate the owner/lessor and the tenant/lessee. 2.2.2 Lessee The lessee is the person or business entity that leases the property or facility from the owner. Simply stated, the lessee is the tenant. In the case of a sublease agreement, the lessee is the tenant of the primary lease holder; the airport sponsor does not have a direct lessor-lessee agreement with the sublease tenant. If the lessee is a commercial enterprise, the tenant’s representative, or contact person, may wish to be identified in the lease parties section. Also, if the eventual tenant of the facility is to operate under a different name than the signatory of the lease, as in a “doing business as” (dba) arrangement, the dba entity must be identified as well. Provision for notification of changes by the lessee, such as moving offices or changing primary contact information, is also important, to ensure consistent communication between the parties. 2.2.3 Premises The premises element of a lease agreement defines the land and improve- ments that, in total, constitute the property subject to the lease agreement. The definition of the premises will include a description of the land to be leased (including square footage, boundaries, and access), a detailed inventory of improvements and equipment to be covered in the lease, and a statement of the general condition of the leasehold improvements (if applicable). A graphic representation of the leasehold, either a site map, airport layout plan (ALP) or aerial photograph, as well as a photograph and/or graphic depiction of any leasehold improvements (if available) should be added as an “Exhibit(s)” included within the lease agreement. The exhibit should clearly demarcate the land, facilities, or other leasehold features that are subject to the lease agreement. 2.2.4 Use of Premises The lease should assure that the land is being leased for a specific purpose and that development is conducted in accordance with a specific site plan. The “use of premises element” of a lease agreement will specifically state the activities that can and cannot be performed within any given leasehold. A hangar lease will typically forbid commercial activity from taking place at a private hangar and may limit what can be stored in the hangar. FBO and 16 Guidebook for Developing and Leasing Airport Property The developer of a commercial airport property may seek a longer lease term to ensure they recoup their facility investment. Ted Stevens Anchorage International Airport was able to effectively lengthen the lease term for the Lynxs Group, the developer of the Alaska CargoPort, with the inclu- sion of four 5-year lease extension options. The Airport was limited to a 35-year lease term by state regulation, which would not have met the needs of the developer. Through the addition of the lease extension options, the Airport was able to guarantee Lynxs 55-year occupancy of the CargoPort.

SASO leases will specifically state (and in the case of a SASO, may limit) the commercial activity that can take place at the leasehold. For land leases, the “use of premises element” will state what improvements may be constructed and for what purposes. The majority of the items included in the use of premises section should be referenced in the Airport Rules and Regulations and Minimum Standards documents. This would enable the air- port to modify this lease element in accordance with revisions to these documents as items and requirements may change over the term of the lease. 2.2.5 Lease Term The lease term states the fixed period in which the lease agreement is in effect. Each lease situation is slightly different, depending on when the lease was negotiated, the size of the ten- ant’s investment, and the useful life of the improvements. While there are no set rules, and dif- ferent airports have differing guidelines based upon applicable state and local statutes, it is important to consider that leases that are too long in term may prevent land from being devel- oped in the most advantageous manner. Conversely, a lease term that is too short may prevent the potential tenant from being able to fully amortize their initial investment for the necessary improvements, thus dissuading interested tenants from entering into airport development projects. The typical airport land lease term will range from a 20- to 30-year term, where, at the termi- nation of the lease, all improvements (financed by the tenant or otherwise) revert back to the airport. The length of the lease term must consider the ability of the developer to fully amortize its investment in improvements over the length of the lease agreement. The larger the investment in leasehold improvements, the longer the lease term will need to be. The airport sponsor, however, must ensure that the lease term does not violate any state or local statute regarding acceptable lease term length for publically owned land. The FAA also advises against longer lease terms and considers any term longer than 50 years to be fee-simple transactions (i.e., the tenant becomes the de-facto owner of the leased property). 2.2.6 Rent The rental amount is usually determined by fair market value, or is the result of a competitive solicitation offer, but can be a combination of both. In a competitive environment, the forces of supply and demand should yield a determination of what is known as market value. While a comparison of sim- ilar facilities (i.e., comparing competing airports of similar size, service, and infrastructure) is an acceptable method of determining market value, other market factors affecting the value of the land can be quite different. If the airport sponsor owns the facility or improvements, the airport may consider a fair market value basis for minimum financial offer to remain competitive with the market. The exception to this rule is in facilities such as airline ter- minals where they were constructed with grants or facility charges. In these cases, operation and maintenance drives rental amounts, and replacement cost and/or development costs are typically not a factor in establishing rental rates. In addition to stipulating the lease rate, the rent element of the lease should also include the timing and acceptable methods of payment, as well as the provisions and penalties associated with the failure to make timely payments. Anatomy of a Lease 17 Baton Rouge Metropolitan Airport has established land lease rates based on fair market value, on a sliding scale. These values are updated every 5 years, after eval- uating comparable properties, with a maximum increase of 10% to ensure rates do not exceed commercially acceptable limits. The sliding scale rewards larger developments. Baton Rouge Metropolitan Airport land appraisal rates, 2005–2009. Parcel Size (Acres) Cost Per Square Foot Cost Per Acre 0–0.25 $0.18 $7,840.80 0.25–0.5 $0.17 $7,405.20 0.5–0.75 $0.15 $6,354.00 0.75–1 $0.14 $6,098.40 1–7 $0.13 $5,662.80 7–10 $0.12 $5,227.20

2.2.7 Escalation Clause One of the most troubling aspects of long-term land leases is providing for the continued adjustment of rental property to compensate for inflation. When rent remains constant during a time of inflation, the airport is losing income, and this period may last for several years. The ideal situation is for an annual reappraisal of property, but this can be relatively expensive to administer. Rate studies may be implemented to establish appropriate rents throughout the lease term, but the most common form of rent escalation is a standard increase every 3 to 5 years, where rent escalation is tied to one or more of the consumer price indices set by the U.S. Depart- ment of Labor. This usually establishes a reasonable rate for the next period of time, while ensur- ing that the costly process of identifying a correct lease rate does not have to be completed more often than necessary. 2.2.8 Operation and Maintenance The operation and maintenance (O&M) element(s) of a lease agreement will specify the divi- sion of responsibility between the lessee and lessor for the cost and effort required to maintain the leasehold to airport standards, and allocate the expenses associated with daily operation of the facil- ity (utility costs). It should be the goal of the airport sponsor to assign to the lessee the general main- tenance and repair responsibility and expense along with grounds upkeep obligations. The O&M section of the lease will list the specific responsibilities of the lessee for leasehold maintenance and upkeep, as well as detail the minimum standards that must be met. These responsibilities and standards are often referenced in the Airport Minimum Standards docu- ment, so referencing this document within the lease agreement will prove beneficial for the air- port in the long term. These documents can generally be modified to reflect changes in the regulatory and operational environment in a much easier fash- ion than individual lease agreements. The airport sponsor may have the duty to perform any maintenance and upkeep that is not specifically referenced as the responsibility of the lessee within the lease agreement or Airport Minimum Standards document. It is in the best interests of the airport to be as detailed as possible when assigning these obligations within the lease, as well as ensuring that the Airport Mini- mum Standards document is as complete, up-to-date, and in compliance with FAA, TSA, environmental, and other applicable regulations as possible. The responsibility of general operation costs, with items such as utilities, janitorial, and landscaping costs, may also be assigned within the operation and maintenance element of the lease agreement. These may also be addressed in an individual subsection of the lease agreement, depending upon the com- plexity of the arrangement. Typically, for stand-alone leaseholds, the lessee will assume all utility and operational costs. However, in the case of an agree- ment in which only a portion of a facility is leased, such as an office space within an airport-owned GA terminal, the lessor may assume utility and operation costs as part of the lease agreement. O&M costs can be a point of negotiation between the airport sponsor and the tenant/developer. With this in mind, the decision of who pays O&M costs and how O&M costs are allocated or shared should be tailored to the specific business circumstances of a given lease agreement. In the case of multiple ten- ants within the same leasehold, O&M costs can be allocated or pro-rated accordingly, rather than the airport sponsor assuming the costs. The airport 18 Guidebook for Developing and Leasing Airport Property Escalation clauses are common and necessary elements in airport leases, particularly those with longer lease terms. The frequency and escalation basis (i.e., set per- centage, inflation based, appraisal) is open to negotiation. The airport sponsor can offer an initial period of deferred rent escalation in order to provide the tenant with cost cer- tainty through a predetermined period. As part of the incentive package offered to EDS/Hewlett Packard to relocate their corporate aviation facility, Collin County Regional Airport structured the escalation clause in the lease agree- ment to provide a fixed rent through the first 10 years of a 40-year lease term. Rent adjust- ments begin at the end of the 10th year and 5 years thereafter.

sponsor may also choose to share O&M expenses or duties with the tenant/ developer to ease the financial burden on tenants and/or prospective tenants. The reality is that O&M costs are a real expense to any airport develop- ment project, and the lease should identify the party or parties responsible for these costs with a spirit of fairness in mind. In some cases, the airport sponsor may be able to provide certain maintenance services or utilities at a rate that is lower than an individual tenant is able to achieve. In other cases, the tenant may be able to provide services more efficiently than the public sector. Efficiency should always be considered when allocating O&M responsibility. 2.2.9 Construction of Improvements The construction of improvements element of the lease agreement should detail the required approval process from the lessor regarding any repairs, renovations, improvements, and alterations. Generally, the airport should receive, review, comment as necessary, and approve any construction and/or alterations before changes are made. This ensures that design stan- dards, quality, and conformance to standards are met and follow the long- term vision for the airport. Needless to say, all planned improvements must comply with the Airport Rules and Regulations and Minimum Standards documents. A land lease may also contain a provision within the construction of improvements clause that provides a clear timeline as to when the construc- tion of improvements and beginning of facility operation must occur. This clause will protect the airport sponsor from the practice of “land banking” (entering into a land lease agreement to reserve land for unstated future development) and ensure that airport land assets are used for immediate highest-and-best use. 2.2.10 Reversion/Reversionary Clause The reversion of leasehold improvements refers to the transition of ownership of all improve- ments to the airport sponsor at the termination of the lease agreement. Permanent leasehold improvements typically revert, while items such as signs, trade fixtures, conveyors, racks, and hoists typically do not. The termination of a lease may not be solely due to the expiration of the term, though that is the most common case. A lease may also terminate prior to the expiration of the lease term should one party in the lease agreement fail to meet the obligations stipulated in the lease. These failures may include failure to pay rent, violation of Airport Rules and Regu- lations, failure to comply with the Airport Minimum Standards, violation of a lease-specific clause within the agreement, or actions that trigger the termination of a lease such as leasing to a lessee’s competitor when a noncompete clause is in effect. If a schedule for the construction of improvements is in effect for a land lease, the lessee should be required to complete the construction of any new facilities within the specific allotment of time or the lease agreement can be terminated. Note that violations or actions that result in the termination of a lease, and associated reversion of improvements prior to the end of the lease term, must be clearly stated in the lease document. The reversion upon termination at the end of a lease term, or upon early termination, prop- erly protects the airport and its interest in the property, yet often leads to issues with improvement Anatomy of a Lease 19 The lease structure at Monroe County Airport offers the tenant an equity position in the leasehold improvements. The leases are struc- tured to allow tenants to maintain partial ownership of the facility at the end of the lease term. This structure gives the tenant motiva- tion to maintain the facility in good repair because their equity stake in the facility will be directly affected by the appraised value of the facility at the end of the lease. In addition, the appraised value of the equity stake may have appreci- ated over the course of the lease term and be worth more than the initial investment in improvements. This type of arrangement is bene- ficial to both the airport sponsor and the lessee, albeit an innova- tive and non-traditional approach. The airport uses a large percent- age of revenues from the leases for a “building fund,” which funds the buyback of facilities at the end of the lease term.

maintenance and upkeep as the lease nears the end of its term. The tenant should understand that leasehold improvements are “wasting assets” that have a limited useful life (typically the length of the lease term), and will depreciate through the course of the lease. In other words, most tenants will typically enter into long-term lease agreements with the understanding that any investment in leasehold improvements will be fully depreciated over the length of the lease and have no expectation of asset recovery at the termination of the lease. Since leasehold improvements will revert to airport ownership, tenants may have little motivation to put additional resources into the cur- rent facility unless enforceable specifications for upkeep and maintenance are appropriately detailed in the lease document or referenced in the Airport Min- imum Standards document. Specifically, a schedule for routine and preventive maintenance and set system inspections with reports to airport management is prudent language to include. Leases that are do not specify reversion, or that leave ownership of the improvements with the developer/tenant, can cause an unexpected or unpre- pared obligation on the part of the airport sponsor. Leases that require the air- port sponsor to purchase the improvements from the tenant may put a financial burden on the sponsor when the lease expires. These obligations must be con- sidered, and funding sources established, if the airport plans on entering into an agreement that requires payment to the lessee at the end of the lease term. 2.2.11 Rights, Reservations, and Obligations of Lessor Many contemporary leases provide the lessor with the right of ingress and egress to leased premises. Leases should also reference the rights of the lessor for the purpose of enforcing com- pliance with the Airport Rules and Regulations and for ensuring that maintenance standards detailed in the lease agreement are being met. In addition, the airport sponsor may wish to include the right to show the property to potential tenants prior to lease expiration, or if the lease is expected to be terminated for any other reason. Since the lessee will have leasehold rights to the improved facility, the lease should specify a reasonable lessor notification period prior to inspec- tion, or establish an inspection schedule within the lease document. Airport management may also want to reserve the right to close the airport facility, including, but not limited to, the runway, taxiway, apron, terminal building, and automobile parking facil- ities when reasonably necessary. This should be at the airport’s sole discretion for the purpose of maintenance, repair, further development or construction, or for the safety of the general public. 2.2.12 Rights, Reservations, and Obligations of Lessee This element of the lease agreement should clearly state the rights that the tenant is entitled to as lessee, and the obligations the lessee must fulfill under the lease agreement. Rights of the les- see typically include, but are not limited to • Ingress and egress, including use of public infrastructure; • Signage (for commercial enterprises), stipulating acceptable size, location, and form; • Quiet enjoyment, defined as possession and unimpaired use of the leasehold without interfer- ence; and • Approved alterations and additions to improvements. The obligations of the lessee section of the lease should include those functions that are typi- cally associated with the operation of the specific facility. Obligations of the lessee should not 20 Guidebook for Developing and Leasing Airport Property The airport sponsor must guarantee the right to inspect the premises in order to ensure compliance with the lease agreement. Right to inspect must extend not only to the primary tenant, but also to all sublessees as well. Anchorage Inter- national Airport, when working with the developer and primary lessee of the Alaska CargoPort, included language in the lease that guaranteed the right of the airport to inspect the premises of all sublessees of the facility. As a result, all sublease agreements administered by the primary tenant include language that guarantees the airport access for inspection.

include items that are addressed in other sections of the lease agreement, such as facility main- tenance obligations or stipulations on use of the premises. Obligations of the lessee vary based on the type of tenant and operation (e.g., private versus commercial, aeronautical versus non- aeronautical), but will generally include the following language: • Conduct and disturbance discussion specifying acceptable code of conduct for facility tenants, employees, customers, and vendor/suppliers. This language typically covers noise, demeanor, and appearance of individuals, vehicles, and equipment; • Economic nondiscrimination language for commercial operators that ensures equitable pricing and services; • Based aircraft reporting requirements; • Other reporting requirements, as stipulated; and • Disposal of trash and waste. Along with the disposal of trash, additional wording should be added under this section of a lease agreement to include oils, fluids, or any hazardous waste. Current federal and some local regulations dictate the amount of hazardous material that is permitted to be stored at any one time. Such is the case with aircraft refinishing facilities and the storage of certain waste oils and fluids. Environmental regulations can be complex and change often, so language directing com- pliance with environmental jurisdictions is important. Such a lease clause (i.e., one that is affected by changes in regulation outside of the lessor’s control) is also referred to as a living clause. 2.2.13 Security Requirements New leases should reference the Airport Rules and Regulations and require any current or future compliance with aviation-specific, federally-mandated security requirements by the TSA and/or Department of Homeland Security. The lease should also state that security requirements may change as the Homeland Security Threat Advisory Levels change, and, if required, the les- see must adjust operations to reflect the current security requirements. 2.2.14 Damage to Facilities Circumstances and responsibility for repairing damages to facilities during the course of the lease term should be described and outlined in this section of the airport lease. Even if the developer pays the entire cost of agreed-upon improvements to airport land, all parties should understand and agree to the manner in which damages will be repaired should damages occur. Specifically, require- ments for premises insurance should be considered, with clarity as to how insurance proceeds shall be used. The timeframe for which repairs shall be made should also be described fully. The airport sponsor’s interest should be well protected in this language, precluding a tenant that is late in the lease term from opting out of its responsibility to repair damaged facilities. Natural disaster, fire, vandalism, and employee abuse should all be considered within this section of the airport lease, clearly identifying the party responsible for repairs in each scenario. This section may also consider provisions for payment of rent in the event of damaged facilities, especially if damages render the leasehold unusable for normal business activity. The airport sponsor should strongly consider the requirement for business interruption insurance so that the tenant has some financial security in the event of significant or catastrophic damage, and so that the airport sponsor is protected from loss of its revenue stream. 2.2.15 Insurance Obligations In order to protect the lessee and the airport sponsor from financial liability arising from the oper- ations of a tenant, insurance requirements should be detailed in all lease agreements. Insurance Anatomy of a Lease 21

requirements, at a minimum, should outline coverage types and amounts so that the airport is protected from financial liability. These requirements will vary based upon the type of tenant (e.g., private versus commercial enterprise), the ownership of the physical structures and equip- ment (e.g., airport sponsor or lessee), the scale of the operation, and the relative risk of harm or loss based upon the type of enterprise. Typical insurance coverage will include (depending upon lessee, ownership of improvements, and anticipated activity): • Property (structure and/or contents), • General liability or commercial general liability, • Automobile, • Fire, • Liability, and • Environmental. The level of coverage required can be set by the airport sponsor or may be assigned by state or local authorities. Excessive coverage requirements may present an undue financial burden on airport tenants and warrants consideration when setting minimum levels. In September 2008, Airports Council International – North America (ACI-NA) surveyed concessionaires at commer- cial service airports of all sizes (ACI-NA Phase II: Concessionaires Survey), focusing on insurance and risk management issues. The report was completed within the past few years and may be a useful resource to the reader of this Guidebook when setting insurance levels. The survey results reveal the various types of insurance an airport should contemplate (e.g., property, general liabil- ity, auto, and fire) as well as minimum amounts for the various categories prevalent at air- ports across the country. The survey report also considers airports of different sizes. Surveys such as these provide relevant benchmarks for the airport sponsor when establishing mini- mum levels of insurance coverage. Because an airport sponsor must balance the need for pro- tection of its interest with the real costs imposed on tenants and airport users, establishing appropriate levels of insurance coverage is an important topic that has direct consequences to the tenant’s ability to maintain a successful business venture. Being consistent with like airports, without leaving the airport sponsor unreasonably exposed to risk, is a responsible approach to finding that balance. If the airport sponsor is the owner of the physical improvements on the land being leased (either through new construction funded by the airport or by means of reversion due to the termination of a lease agreement), the airport may be responsible for premises insurance. An umbrella policy may be the most effective approach, though liability, contents (e.g., aircraft and/or equipment), and other stipulated hazards such as environmental contamination generally remain the respon- sibility of the tenant. It is the responsibility of the airport sponsor to ensure that the lessee and any sublessee are in compliance with the insurance requirements outlined within the lease. This is typically accom- plished by requiring the lessee to provide airport management with appropriate insurance doc- umentation (Certificate of Insurance) on an annual basis from a reputable insurance firm licensed to do business in the state in which the airport is located. The lease agreement may include language that requires the lessee to notify the airport of the cancellation of insurance, within a stipulated time frame, should such an event occur. 2.2.16 Environmental Environmental awareness and consciousness has risen significantly in past decades within many facets of modern life. Real estate, and more specifically, leased airport property is no exception. In fact, environmental consideration is now routinely a point of significant discussion in lease negotiations. 22 Guidebook for Developing and Leasing Airport Property

Environmental aspects to be considered in airport leases include the current environmental condition of land and/or airport facilities; responsibility for past, present, and future environ- mental remediation; environmental insurance requirements; and landlord assurance that the tenant will be financially capable of resolving potential liability exposures. At the very minimum, all parties of an airport lease agreement should agree on the environmen- tal condition of the property at the time the property is placed under control of the tenant, as well as the condition the property is expected to be in at the time it reverts to the airport sponsor. Specif- ically, soil conditions and historical data regarding fuels, solvents, and other contaminants should be discussed and a baseline for expectations established. If existing buildings are a part of the airport lease, asbestos and other building materials/equipment should undergo a similar baseline survey. Many airports have experienced decades of tenants and operations on a given piece of prop- erty. As acceptable activities have changed and environmental awareness has increased, past activities and practices may no longer be appropriate or allowed by the airport sponsor. Fuel releases from aircraft, for example, were dismissed more readily in the early days of aviation than they are today. Airport sponsors today are held to high standards as environmental stew- ards, especially in the areas of water quality and storm water management, both of which could be affected by tenant fuel releases. All parties should also agree on the level of environmental insurance, or liability insurance that covers environmental issues, as a term of the airport lease. Even if both parties agree that levels and standards may change over the course of the lease, an honest and constructive discussion can save all parties pain in the future. The airport sponsor deserves, and should expect, to be indem- nified by the airport tenant on matters environmental and otherwise. The tenant should have an understanding of the prevailing obligations and associated expenses that are imposed by the airport sponsor regarding environmental insurance. A third aspect of a minimum level of environmental discussion should be the airport sponsor’s confidence in the ability of the tenant to environmentally remediate airport property in the event of contamination. Of course, environmental insurance speaks directly to this point, but environ- mental insurance can be very expensive. Just as the airport sponsor must gauge the tenant’s ability to make payment for rents, fees, and charges, it must also gauge the tenant’s ability to remediate contamination should environmental contamination occur. Other means of establishing security of obligations in this regard are bonds, letters of credit, and/or funds in escrow. As with many issues, the airport sponsor walks the fine line of protecting the airport’s assets without imposing undue hardship on the tenant who wishes to utilize the airport. 2.2.17 Taxes and Fees The airport sponsor, typically a public entity that operates the airport for public benefit and use, is likely exempt from many taxes and fees, including property taxes. When private develop- ment in support of a commercial venture takes place on public property, interpretation as to how the tenant of the leased property is taxed varies widely and can easily change with the political winds and economic climate. Airport sponsors, therefore, should strive to protect themselves from incremental development costs and associated tax exposure by appropriately passing any tax liability through to the tenant that occupies the airport property. These provisions and pro- tection of the airport sponsor should be fully described within the language of the lease. Similarly, the airport sponsor should be prepared, through language within the lease, to pass through any fees that might be assessed to a given airport development project on leased airport property. For example, impact fees that some communities levy on new development to offset the public investment required to support that development should be passed through to the tenant, even though the airport sponsor is the owner of the land being developed. Anatomy of a Lease 23

2.2.18 Liens Improvements on leased airport property are often financed, and the bank or lending institu- tion is likely to require some type of security against the money to be loaned. Liens are the common instrument in this regard, as the lender has a recorded interest in the improvements and a right to claim ownership of those improvements should the borrower default on the loan. Liens are typ- ically recorded at the appropriate courthouse as a legal claim against real property. In the event of default of the loan, the lender will have first claim to the property if it has a first lien position, or stand behind the first lien holder in the case of a second lien position. Lien position establishes priority for satisfying claims against the real property that secures collateral interest. The caveat to this basic real estate principle is that the airport sponsor is restricted from disposal of property without FAA concurrence. In this case, a lien on the property itself must be precluded in the lease agreement. Lenders cannot be allowed to dispose of public airport property in the interest of satisfying a defaulted loan. The improvements can serve as security against debt— though the airport sponsor would typically restrict the placement of liens to new development it has approved—with strict conditions for cure (e.g., payment of outstanding rents owed). Specifically, lease language should include airport sponsor approval of any new tenant the lender wishes to place in facilities encumbered by a lien, in the event of loan default, to preserve com- patibility of the airport sponsor’s vision for airport development. Ultimately, a lien on tenant improvements will generally provide less security than a traditional lien placed on fee simple property owned by the borrower. 2.2.19 Defaults The defaults section of a lease should stipulate the scenario(s) in which the terms of the lease have been violated. This section should include methods for curing the default, as well as periods of time that must pass without curing before the lease can be terminated. For example, typical default provisions will include termination language that speaks to what happens in the event the tenant does not pay the agreed-upon rents. But, the defaults section should also include language that allows the tenant to cure, the timeframe in which this must occur, and how penalties or late fees are to be applied. Additionally, default language in this example should address how the airport sponsor will apply or pursue security deposits, bonds, or letters of credit. Essentially, the defaults section will describe which (if not all) violations of the lease provisions will trigger lease default, the actions the airport sponsor intends to take in the event of default, and the recourses that the lessee is entitled to if provisions and/or terms of the lease are not met. Default language that speaks to a failure to pay rent is perhaps the most common, but should not be the only parameter for lease default language. Failure to comply with airport rules and/or regulations, environmental damage to airport property, inappropriate use of airport land and/or facilities, and illegal activities are other examples that the airport sponsor should consider address- ing within the context of a defaults section of a lease. Language that requires the tenant to comply with local, state, and federal laws, rules, and regulations, which may change during the course of the lease term, should be considered in order to protect the airport sponsor if the regulatory environment changes. Default clauses should be considered from both the airport sponsor’s perspective and the lessee’s perspective. Specifically, the airport sponsor should consider events that would be unacceptable to the tenant and allow for language that responds to the needs of the lessee. However, the airport sponsor should never restrict its ability in any of the lease provisions to operate and develop the airport in a manner that is consistent with federal grant assurances. While the defaults sec- tion should consider and accommodate, when able, the perspective of the tenant, the lease should not restrict or penalize the airport sponsor in carrying out its primary objective of oper- 24 Guidebook for Developing and Leasing Airport Property

ating and developing a public airport within the parameters of state and federal regulations and guidelines. 2.2.20 Assignments and Subletting The assignment of a lease is the process of transferring all rights and provisions of a lease from one tenant to another. A request for assignment may occur because one company is being acquired or sold by another, so the legal obligations need to transfer to the new legal entity. Another request may occur simply because the developer wants to divest of the liability and/or sell any equity interest in the facility. Subletting is the process of leasing part or all of the facility to another party without transferring any of the lessee’s responsibilities to the airport sponsor. Assignment and subletting language is important in an airport lease, especially in circum- stances where permanent improvements need to be amortized over long periods of time to meet market pricing. The developer and/or the financier of the project will typically want some assur- ance from the airport sponsor that, if circumstances dictate, another tenant can replace the ini- tial tenant and/or subletting is allowed if the financial and/or business circumstances of the tenant change over time. The initial tenant may sign a lease that is sufficient in length to amortize investment in improvements, but many things can happen over the course of a 20- or 30-year lease. For the reasons just described, many airport leases include language that allows assignment, subletting, or both, within specific parameters. If improvements were made on airside property for the storage of aircraft, the allowable uses of the lease, including any assignment or subletting, should preclude nonaeronautical activity. Restrictions on use affect the market price of a facil- ity, so the developer and lender often look for flexibility in the lease that will allow assignment and/or subleasing in order to build confidence in the commercial viability of a project. At the minimum, the airport sponsor should consider assignment and subletting language that passes all obligations of the initial lease to any assignee or subtenant. The airport sponsor often requires pre-approval of any assignment or subletting, though approval should not be unduly or arbitrarily denied if the assignee and/or subtenant meets the spirit of the initial lease agreement. Some lease agreements include language that requires the initial tenant/developer to pay a percentage of any profit derived from an assignment or sublease, or a fee for the adminis- trative effort to consider and execute an assignment and/or a sublease. All of these aspects should be considered during the lease negotiation process and balanced with the overall objectives of the airport sponsor. 2.2.21 Regulatory Compliance The regulatory compliance section of a lease is a vitally important component of an airport lease agreement in that it assists the airport sponsor in keeping pace with a changing regulatory environment. The airport sponsor can and should require regulatory compliance with known applicable local, state, and federal regulations. In addition, the regulatory compliance section should pass along responsibility for complying with the inevitable additions and/or modifica- tions to existing regulations that will certainly occur over the course of decades. For example, an airport sponsor, as landowner, is responsible for complying with water qual- ity regulations of the Environmental Protection Agency. The airport sponsor should pass along water quality responsibilities to its tenants, within their respective leaseholds, for complying with these same regulations, requiring participation in the airport’s storm water protection plan, and future compliance with any new regulations that may come over the course of the lease. Regulatory compliance requirements should be broad enough to encompass the many areas that affect the airport sponsor as owner of a public airport. Federal aviation and environmental Anatomy of a Lease 25

regulations are prevalent at all airports, while a mix of local, state, and other federal regulations exist and vary depending on location. The regulatory compliance section of an airport lease agreement must acknowledge and require the tenant, as one member of an airport’s commu- nity, to adhere to the same standards for compliance as the other members of the airport and the airport community as a whole. 2.2.22 Hold Harmless Provision The lease between the airport sponsor and the tenant should include a hold harmless or indemnity clause that protects the airport sponsor from any legal action, suits, proceedings, claims, damage, loss, liability, cost, or expense that may be filed against the lessee for any reason arising from the operation and/or negligence of the lessee. In the spirit of quid pro quo, the air- port sponsor is typically asked and often evaluates reciprocal language that considers the lessee’s position. Many airport leases include some level of hold harmless protection for the lessee as well, protecting them in the case of negligence on the part of the airport sponsor. 2.2.23 Nondiscrimination Part 21 of 49 CFR (Code of Federal Regulations) outlines the mandate for nondiscrimination in federally-assisted programs of the Department of Transportation. Airport sponsors that receive federal grant funding through the Airport Improvement Program (AIP) are bound by grant assurances that prohibit discrimination on the grounds of race, color, or national ori- gin. Tenants leasing property that is part of an airport’s lands fall within the parameters of a federally-assisted transportation program, so the airport sponsor should include nondiscrimi- nation language in its lease agreements, which is typically found under a “nondiscrimination” heading of the lease document 2.2.24 Living Clauses Living clauses play an important role in the lease document. These clauses allow existing agree- ments to evolve as associated regulations and laws change during the course of the lease term (e.g., wildlife, security, and environmental). Rules and Regulations, Minimum Standards, Rates and Charges, and Schedules of Insurances are other examples of documents that will likely change over time and that can be addressed through living clauses to maintain consistency. Airport sponsors should always be aware of ongoing regulation amendments and changes. It is the airport sponsor’s responsibility to ensure the airport and all encompassing aspects conform to state and federal laws. Airport tenants should remain current on these laws, as the changes may require substantial financial obligations or a complete change of operating standards. 2.2.25 Force Majeure The force majeure provision of an airport development and/or airport lease should consider unavoidable causes for delay due to acts of God and natural disaster, which may set the stage for failures to perform the provisions of the agreement. Force majeure clauses are often provided to address delays in construction due to weather and should consider both the developer/tenant and the airport sponsor perspectives. Specifically, agreements should include force majeure lan- guage when the airport sponsor has agreed to do certain things or make certain improvements. For example, the airport sponsor may agree to construct a taxiway extension to meet the needs of a new development, but the agreement should include force majeure language that protects it 26 Guidebook for Developing and Leasing Airport Property

if a hurricane or unusual rainfall delays construction and places the sponsor in the position of being unable to meet the obligations of the lease/development agreement due to circumstances beyond its control. 2.2.26 Holdover Holdover provisions of an airport lease simply allow the airport sponsor to extend the terms of an existing airport lease, in the event both the airport sponsor and the tenant desire to con- tinue the relationship as it exists, without execution of a new lease. Holdover provisions are use- ful in bridging gaps and meeting short-term needs of the parties involved, but should be used sparingly. Renegotiation of a lease or transition of lessees are typical uses of holdover provisions, where it is mutually beneficial for all parties to preserve the terms of the existing agreement with- out rushing negotiation for the sake of meeting a deadline, or for bridging the operational gaps that might occur between tenants. At the end of a long-term lease, the revenue associated with a lease may be below market value, so holdover provisions of that lease may result in a reduced revenue stream to the airport sponsor. Holdover provisions should be used sparingly. Holdover provisions should not be confused with extension options, as extension options in- volve an additional period of time, as well as adjustment in rental rates for that extended period. Holdover language may include an adjustment in rents as well, but this provision is meant to provide short-term extension of the protections and terms described within the lease document and not the protection of the tenant that is reluctant to negotiate a new agreement. For this rea- son, the airport sponsor may choose to negotiate a premium into the lease for the exercise of holdover provisions, as well as the ability to waive increased rents or premiums, if the applica- tion of holdover provisions is for benefit of the airport sponsor. 2.3 Optional Lease Elements Optional lease elements are typically added to address financial and business concerns of com- mercial lessees and are designed to protect the investments made in on-airport facilities. These lease elements are not a requirement. They are negotiated into the agreement by the lessee in order to protect the lessee’s interests. However, their addition to the lease agreement is at the discretion of the airport sponsor. The airport sponsor must be certain that the addition of any language grant- ing or limiting commercial activity does not provide a single tenant with a potential commercial advantage over its competition, limit on-airport competition, or hinder the highest-and-best use of airport land or facilities. Any lease element that does so may put the airport in violation of FAA grant assurances. These grant assurances are addressed in greater detail in Chapter 3, Sec- tion 3.2 (Grant Assurances and Federal Compliance) of this Guidebook. 2.3.1 Noncompete Clause A noncompete clause is intended to protect the business and financial position of an airport commercial lessee by limiting on-airport competition in the field of commerce in which the les- see is engaged. The clause states that the airport will not lease a property to a commercial entity that will provide the same services and be in direct competition with the lessee. A noncompete clause is most common among FBOs and maintenance, repair, and overhaul (MRO) facilities and business providing essential fueling and maintenance services to airport users. A noncom- pete clause will typically provide the lessee with a means to terminate the lease agreement with- out penalty should the terms be violated. Anatomy of a Lease 27

The airport sponsor should be wary when entering into an agreement that contains a noncompete clause because it may be perceived as offering the existing tenant a monopoly with all of the negative connotations associated with such an arrangement (e.g., the potential for higher prices and lower ser- vice levels). Without proper context, noncompete language can also be viewed as a violation of Federal Grant Assurances 22 and 23 that address economic nondiscrimination and the granting of exclusive rights. When structured prop- erly, noncompete language can allow the airport sponsor to grant access to another competing commercial enterprise, while respecting an existing tenant’s interests. In other words, noncompete language can give the airport sponsor the flexibility to pursue a superior tenant should it choose to do so, while respect- ing the existing tenant’s perspective that a new entrant would force them out of the market, and giving that existing tenant an out. Such an arrangement would be most prevalent in circumstances where the existing tenant has very little or no investment/debt in the facilities they occupy. This type of language is meant to provide the existing tenant a means to terminate the lease should competi- tive conditions on the airport change. The airport sponsor should, however, be cautious not to establish a scenario in which negative consequences will occur should it pursue new tenants/competition. Specifically, if the existing tenant is paying a large amount in rents and fees, and has noncompete language in its lease, the airport sponsor may have a disincentive to pursue new tenants. A negative financial impact to the sponsor and presumed disincentive can be perceived as an exclusive right to operate. Ultimately, it is the airport sponsor’s decision whether or not to enter into such an agreement, and it should be made only after conducting a detailed analysis of the nature of the potential lessee’s business in relation to the cur- rent availability of such services, the overall airport need and desire for the lessee’s services, and the perceived ability of the lessee to adequately provide said services. 2.3.2 Right of First Refusal A right of first refusal is a contractual right placed in the lease agreement that gives the lessee the option to enter into a lease agreement with the lessor for a specified airport prop- erty in advance of an interested third party. This does not specifically limit the airport from marketing the property, but it may limit the property’s marketability if prospective ten- ants are aware that the property is subject to a right of first refusal. An existing commercial tenant may demand such a clause to limit potential competition on-airport, or to ensure space and resources for future expansion. The airport sponsor will need to enter into such an agree- ment with caution, particularly if the lessee seeks to place set lease rates into effect for the property in advance (e.g., lease rate will mirror rates of those for the lessee’s current prop- erty). Such stipulations may hinder the airport’s ability to achieve market value rent for the property in question. Grant Assurance 24, Fee and Rental Structure, states the air- port sponsor shall “maintain a fee and rental structure for 28 Guidebook for Developing and Leasing Airport Property Albany International Airport, in an effort to attract HondaJet’s northeastern sales and service center, offered several incentives and guarantees to make the Albany site as financially and operationally attractive possible. Among the concerns of Honda- Jet was the ability to accommodate future expan- sion. To alleviate this concern, the airport included a “right of first refusal” clause in the lease agree- ment. This clause allows HondaJet to lease an additional 45,000 square foot parcel adjacent to the chosen development site prior to the airport leasing this land to any other interested party. Clauses such as these protect a tenant’s investment by ensuring that their future development and expansion needs are guaranteed, while still allowing the airport to market the property. Tampa International Airport had two large, empty maintenance hangars they were actively market- ing; one vacated by US Airways and the other vacated by Delta Air Lines. The airport was able to attract interest in the US Airways facility from PEMCO World Air Services. However, PEMCO was concerned that should a competitor locate in the vacant Delta facility, its ability to profitably operate in the region would be compromised. One of the concessions the airport made when negotiating PEMCO’s lease agreement was the inclusion of a noncompete clause that granted PEMCO the right to void the lease if another third-party MRO was located on-airport during their lease term. Despite this element in the lease, the airport still actively markets the Delta hangar.

the facilities and services at the airport that will make the airport as self-sustaining as possible.” This means achieving market value rates for all available property. 2.3.3 Percent of Revenue Another method of revenue recognition for the airport sponsor, a method that is common in terminal concessions lease agreements, is percentage of gross revenue payment. The airport sponsor may enter into an agreement with a les- see that may reduce the base cost per square foot rate of a land and/or facility lease, but make up for this loss in airport rev- enue by stipulating that the airport receives a percentage of the tenant’s gross revenue derived from the activity at the facility. Typically, a floor, or minimum monthly payment is set, and the greater of the minimum payment or percentage of profits is paid to the airport. This approach could, how- ever, require a greater involvement of the airport, an agreed- upon auditing process, and solid understanding of what defines gross revenue. 2.3.4 Term Extension Options Flexibility in the length of the lease term can be achieved through extension provisions written into the lease. These can be 5- to 10-year extension clauses that effectively extend the lease term to a length that is mutually beneficial for both the airport sponsor and the tenant. This is a particularly beneficial tool when an airport sponsor is limited by statute (state or local) from issuing lease terms for a period long enough to allow a tenant to amortize its facility investment. The airport sponsor will want to ensure that any lease rate escalation occurs periodically in order to keep pace with market rates and current appraisal values. Anatomy of a Lease 29 Term extension options are a common component of a lease agreement that will often allow the developer and tenant to recoup initial investment in improvements or extend the useful life of improvements. Knepper Press, when developing the Clinton Commerce Park at Pittsburgh International Airport, secured two 10-year lease extensions on the initial 29-year lease term. These options ulti- mately made the lease deal more attractive for Knepper Press and assured the airport sponsor a long-term, viable tenant. Tampa International Airport was able to entice PEMCO World Air Services, an MRO operator, to a 150,000 square foot maintenance hangar that was vacated by US Airways. PEMCO, unsure of the ulti- mate financial success of the new venture, was wary of entering into a long-term fixed lease. The airport agreed to a revenue sharing arrangement, with payments of a 1.3% share of PEMCO’s gross revenue generated from the facility. This arrange- ment allows the airport to reduce the lessee’s fixed lease payments, which appeals to the tenant desir- ing reduced start-up costs, but ties the airport directly to the success of the lessee’s enterprise. The airport has the potential for greater returns over the life of the lease in this scenario.