Estimating Market Value and Establishing Market Rent at Small Airports (2020)

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10 2.1 Introduction Market value and market rent are often misinterpreted and misunderstood, not just in the aviation industry but in property management and in general real estate practices. In the aviation industry, market value and market rent are often treated as interchangeable terms, which can be misleading. As discussed throughout this report, market value, by definition, represents the price to “buy” an asset—what the property is worth. Conversely, market rent represents the price to “lease” (or rent) an asset—the price to use the property for a specified period of time (e.g., monthly or annually). There are differing opinions throughout the aviation industry regarding the nuances and methodologies to estimate market value and establish market rent. Without clear definitions of each term and a clear explanation of the application, as provided in this report, the nuances of estimating market value or establishing market rent cannot be adequately addressed. Also, there are various methodologies across the aviation industry related to market rent adjustment mechanisms and the frequency of adjustment. The issue is further complicated in that there is no universally required methodology from the FAA for estimating aeronautical market value or establishing and adjusting aeronautical market rent. Conversely, the FAA provides clearer guidance as to the methodology for conducting appraisals and the situations in which an appraisal is required for non-aeronautical land and improvements, discussed further herein. While some airports may utilize competitive processes (e.g., request for proposals— RFP), other airports may rely strictly on negotiation. Some airport sponsors may survey airports in the local market, within the state, or airports deemed comparable regardless of location, which can become problematic due to limited guidance on what airport characteristics should be considered in determining comparability. Some airports determine market rent adjustments based on the terms of the specific lease agreement; however, this can be problematic if an agreement is vaguely written or if different adjustment methodologies are used among similarly situated airport lessees. Additionally, there is limited guidance specifically pertaining to airport land and improvements outlining the property characteristics that should be considered. There are also conflicting opinions on how certain considerations should ultimately impact a market value or market rent conclusion. For example, • How do development and lease agreement terms and conditions relate to capital investment on airport property? • Which compensation mechanisms, or combination thereof, for use of airport property are appropriate (i.e., rent, fees, investment)? C H A P T E R 2 Understanding Market Value and Rent

Understanding Market Value and Rent 11 • What is the appropriate airport sponsor rate of returns on capital investment for deter- mining rent? • Do additional attributes (such as ingress/egress aprons) that may not be included in the leased premises but are utilized on a preferential basis impact the value or rent of a hangar? • Are the economic benefits of a potential development or other off-airport benefits to be considered in estimating market value or establishing market rent? This variability, centered on a key aspect of a lease agreement, ultimately leads to uncertainty for the airport sponsor, as well as developers, real estate agents, lessees, and sublessees. Addi- tionally, discussions with prospective or existing lessees lead to missed opportunities and failed negotiations when one party feels the prevailing realities of value or rent for airport properties are not adequately addressed. However, before the nuances of estimating market value or establishing and adjusting market rent can be appropriately discussed, it is imperative to outline a clear understanding of these terms—market value and market rent. As such, this chapter outlines and explains the definitions of market value and market rent. Additionally, each term is further explained through examples, as well as through consideration of FAA guidance. 2.2 Market Value Definition Although the definition of market value varies by source, the concept is always rooted in the price to “buy” an asset and the need for the buyer and seller to act knowledgeably without undue duress. In fact, the definition of market value is so important that the Uniform Standards of Professional Appraisal Practice (USPAP) requires the definition be stated in appraisals. The requirement for both the buyer and the seller to be knowledgeable further substantiates the need to have a common, clearly delineated process to address the specific issues inherent to general aviation properties. Market value, for the purposes of this report and as defined by the Appraisal Institute in the Dictionary of Real Estate Appraisal, is “the most probable price which a specified interest in real property is likely to bring under all conditions requisite to a fair sale, the buyer and seller [i.e., both parties] each acting prudently and knowledgeably, assuming the price is not affected by undue stimulus.” Implicit in this definition, and as outlined in the Dictionary of Real Estate Appraisal, is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby • Buyer and seller are typically motivated; • Both parties are well informed or well advised, and both act in what each party considers its best interest; • A reasonable time is allowed for exposure in the open market; • Payment is made in terms of cash in U.S. dollars or financial arrangements comparable thereto; • Consideration is given to all available economic uses of the property at the time of the appraisal; and • The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. In any lease agreement, two main perspectives apply to value. For this report, the air- port sponsor/lessor and the lessee represent these perspectives. Each perspective holds, by way of the lease, a different value consideration consisting of leased fee interest (ownership interest held by the airport sponsor/lessor) and the leasehold interest (rights held by the lessee).

12 Estimating Market Value and Establishing Market Rent at Small Airports Implicit in each definition is that these value considerations exist concurrently. For example, if an airport sponsor enters into a 30-year lease agreement, value is created for both parties, as follows: • Leased Fee Estate—the airport sponsor has the right to receive rent for the term specified in the lease agreement (e.g., 30 years) and any additional reversionary rights associated with the ownership of the improvements upon the expiration of the lease agreement term. • Leasehold Interest—the lessee has the right to occupy and use the land and/or improvements for the term of the agreement and construct improvements on the leased premises for use by the lessee. Market value represents the price to “buy” an asset; as such, it is imperative to understand and define the value consideration (e.g., leased fee estate or leasehold interest) being analyzed. However, understanding the market value of a leased fee estate (held by the airport sponsor) will require an analysis of the obligations for a federally obligated airport. The value consider- ation being evaluated will define what is ultimately for sale and being purchased. Utilizing this definition and the type of value considerations, this report will address the requirement for each party to act knowledgeably by implementation of a common, clear process to estimate market value. 2.3 Market Rent Definition Market rent, as compared with market value, represents a completely different perspective. Rather than the price to “buy” an asset (which ultimately results in a transfer of ownership), market rent represents the price to “lease” an asset (e.g., monthly or annually). Effectively, market rent is the price to use and occupy another entity’s property (land and/or improvements) for an agreed-upon period. Throughout the aviation industry and oftentimes when market value and market rent are used interchangeably, market rent appears to be the underlying subject of debate. In addition, some references will combine the two concepts and refer to “market value rent” or “market value rates.” For example, as outlined in FAA Order 5190.6B Chapter 15, Permitted and Prohibited Uses of Airport Revenue, “Rental of land to, or use of land by, the sponsor for non-aeronautical purposes at less than fair market value rent is considered a sub- sidy of local government and is a prohibited use of airport revenue.” While the FAA’s intention can be surmised (i.e., rental or use of land by the airport sponsor at less than fair market rent is considered a subsidy and a prohibited use of airport revenue), the interchangeable and contra- dictory use of terms can ultimately result in confusion. As such, this report defines market rent as the most probable rent a specified property should bring in a competitive and open market, reflecting the terms and conditions of a specified lease agreement. Said terms and conditions include rental adjustment and revaluation, permitted uses, use restrictions, expense obligations, term, concessions, renewal and purchase options, and tenant improvements. As with value consideration, it is imperative to understand the underlying details of the rent being analyzed. As discussed in this report, rent consideration can consist of land and/or improvements. However, these considerations can have multiple perspectives of analysis, including type (aeronautical or non-aeronautical), use (commercial, non-commercial, non- profit, or agriculture), basis (wholesale or retail), and lease structure (triple net or gross). Utilizing this definition and the type of rent considerations, this report will address the methodology to establish and adjust market rent by implementation of a common, clear process.

Understanding Market Value and Rent 13 2.4 Key FAA Guidance and Compliance Considerations A federally obligated airport sponsor must acknowledge certain FAA guidance and compli- ance considerations and implement them accordingly. While current and prospective lessees or tenants may not be obligated to comply with all considerations, the airport sponsor should ensure each party understands these elements. This will support a more successful negotiation process, as outlined in Section 6.3. Compliance considerations include the FAA Assurances, orders, polices, advisory circulars, and other guidance and compliance materials. As stated throughout this report, the Assurances represent those obligations with which federally obligated airports must comply for having received Airport Improvement Program (AIP) funds. Assurance 24 requires that the airport sponsor “maintain a fee and rental structure for the facilities and services at the airport which will make the airport as self-sustaining as possible under the circumstances existing at the particular airport, taking into account such factors as the volume of traffic and the economy of collection.” Further, the FAA states in the Policy Regarding the Establishment of Airport Rates and Charges, “rates, fees, rentals, landing fees, and other service charges (‘fees’) imposed on aeronautical users for the aeronautical use of the airport (‘aeronautical fees’) must be fair and reasonable.” The FAA indicates in the Policy Regarding the Establishment of Airport Rates and Charges that “reasonable methodologies may include, but are not limited to, historic cost valuation, direct negotiation with aeronautical users, or objective determinations of fair market value”: • Historic Cost Valuation—As the focus of this report is to identify characteristics of airport property for estimating market value, historic cost valuation will be discussed from a general perspective and not a small airport perspective. A historic cost valuation, as outlined in the Policy Regarding the Establishment of Airport Rates and Charges, “must allocate capital and operating costs among cost centers” in accordance with a reasonable, consistent, and transparent methodology: (1) “costs of airfield facilities and services directly used by the aeronautical users may be fully included in the rate base” and (2) “costs of airport facilities and services used for both aeronautical and non-aeronautical uses (shared costs) may be included in the rate base if the facility or service in question supports the airfield activity reflected in that rate base.” The rate base is defined as the “total of all costs of providing airfield facilities and services to aeronautical users (which may include a share of public-use roadway costs allocated to the airfield in accordance with this policy) that may be recovered from aeronautical users through fees charged for providing airfield aeronautical services and facilities.” While the historic cost valuation is an acceptable methodology from the FAA’s perspective (and pre- dominately finds application at larger air carrier airports), this approach may not necessarily be consistent with the realities of the prevailing market for small airports. • Direct Negotiation—The Policy Regarding the Establishment of Airport Rates and Charges is non-descriptive in terms of the methodology for initiating and completing a negotiation process. A negotiation, as defined in Appendix A of this report, is to confer with another party so as to arrive at the settlement of a particular matter, in this case, market value or market rent for airport properties. A negotiation process can result in a market transaction as long as (1) it is an open market (which may include a competitive process or appropriately advertised opportunity), (2) the buyer (lessee) and seller (airport sponsor) are acting prudently and knowledgeably, and (3) the price is not affected by undue stimulus. In this process, it is imperative to apply the results of an objective analysis to ensure the lessee and airport Airport sponsors must ensure compliance with state guidance and requirements as well as federal guidance. For example, the Texas Transportation Code states, “The charges, rentals, and fees must be reasonable and uniform for the same class privilege or service and shall be established with due regard to the property and improvements used and the expenses of operation to the local government.”

14 Estimating Market Value and Establishing Market Rent at Small Airports sponsor are acting knowledgeably. Through the survey conducted specifically for this report, a negotiation (with or without the support of an objective analysis) was identified by 17% of the respondents as the preferred methodology to estimate market value or establish market rent. While Chapter 6 of this report addresses the negotiation of development and lease agreements, this process should be rooted in an objective analysis to estimate market value or establish market rent as a beginning point of discussion. • Objective Determinations of Fair Market Value—As discussed previously, the inter- changeable use of market value and market rent is misleading and ultimately leads to mis- understandings. However, the FAA’s identification of objective analysis as an appropriate methodology results in the need for a common, clearly delineated process to address the specific issues inherent to airport properties when estimating market value and establishing market rent. While the FAA provides airport sponsors significant latitude in the methodology for estimat- ing market value and establishing market rent, it specifically addresses certain common types and uses of airport property at small airports, including non-aeronautical use and not-for-profit entities. Non-Aeronautical Use Order 5190.6B, the Airport Compliance Manual, states that non-aeronautical use of airport land and/or improvements must be leased at market value. The Airport Compliance Manual also states, “Fair market fees for use of the airport are required for non-aeronautical use of the airport and are optional for non-airfield aeronautical use.” Additionally, the FAA Policy on the Non-Aeronautical Use of Airport Hangars states, “The [airport] sponsor is required to charge a fair market commercial rental rate for any hangar rental or use for non-aeronautical purposes.” More recently, the FAA Reauthorization Act of 2018 codifies the requirement “that an airport owner or operator [sponsor] receives not less than fair market value in the context of a com- mercial transaction for the use, lease, encumbrance, transfer, or disposal of land, any facilities on such land, or any portion of such land or facilities.” The non-aeronautical use of airport land and improvements (including hangars) is addressed in Chapter 3, FAA Guidance and Policies. Not-for-Profit Entity As stated throughout this report, the Assurances represent those obligations with which federally obligated airports must comply to receive AIP funds. As outlined in the Airport Compliance Manual, airport sponsors “may charge reduced rental rates to aviation museums and aeronautical secondary and post-secondary education programs conducted by accredited education institutions to the extent that civil aviation receives reasonable tangible or intangible benefits from such use.” Further, the Airport Compliance Manual states that an airport sponsor “may also charge reduced rental rates to Civil Air Patrol units operating aircraft at the airport.” Public Law 114-238 created a new statutory exemption to allow airport sponsors to reduce rental rates for certain federal or state governmental entities “that support the operation of military aircraft by the Air Force or Air National Guard—(i) at the airport; or (ii) remotely from the airport.” However, as discussed in the preceding section (Non-Aeronautical Use), the FAA Reauthorization Act of 2018 outlines new requirements pertaining to non-aeronautical use of airport land and/or improvements. As such, before implementing a process to establish market rent for land and/or improve- ments utilized by a not-for-profit entity, the airport sponsor should determine the underlying policy direction pertaining to not-for-profit entities. An airport sponsor may, at the airport sponsor’s sole discretion, consider charging a reduced rental rate for not-for-profit aeronautical

Understanding Market Value and Rent 15 use of land and/or improvements owned and operated by the airport sponsor. However, consistent with FAA guidance, civil aviation must realize reasonable tangible or intangible benefits from the not-for-profit entity’s use of airport land and improvements at a reduced rate. The underlying policy direction should be flexible, allowing each opportunity to be analyzed on a case-by-case basis after resolving the following: • Measurement and quantification of the tangible and intangible benefits to civil aviation; • Analysis of the land and/or improvements requested for use, including the size of the land parcel, number of tiedown locations, and number of hangars; and • Location of the requested land and/or improvements. 2.5 Chapter Review This chapter built on Chapter 1 and began outlining the definition of market value and market rent while tying together applicable FAA guidance. These definitions, outlined in Figure 2-1, are instrumental to understanding the reasonable methodologies recommended by the FAA, as well as addressing non-aeronautical and not-for-profit uses of airport property. The most probable price a specified interest in real property is likely to bring under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, assuming the price is not affected by undue stimulus giving consideration to all available economic uses of the property. The most probable rent a specified property should bring in a competitive and open market reflecting the conditions and restrictions of a specified lease agreement, including the rental adjustment and revaluation, permitted uses, use restrictions, expense obligations, term, concessions, renewal and purchase options, and tenant improvements. M ar ke t V al ue M ar ke t R en t Figure 2-1. Chapter 2 key aspects.