There is an abundance of optimistic forecasting for 2010 and beyond. A good portion of this seems to be speculative and tied to things other than market fundamentals. As a follow up to our ‘Business Jet Values in the New Economy’ (Dec 09), we are going to look at markets from a transaction perspective and present the market data that led up to the height of the market, its subsequent erosion and near term status, in hopes of quelling some of the rhetoric. For this purpose, we will present a couple of aircraft with the understanding that the facts speak to the majority of business jets.
How did economic downturns affect aircraft pricing and sales levels?
In 1995, the US economy was coming out of a recession and the Dot-com era was underway. Market Price and Market Value of business jets were very similar from 1990 to 1995, indicating a rational market balance. Economically, as the recession subsided, a combination of rising stock prices, low interest rates and abundance of venture capital created such speculation and exuberance that companies dismissed standard business models, focusing instead on increasing market share.
From 1995 thru 2000 business jets were selling at unprecedented premiums. A 1992 GIV that sold new for 22M, resold 7 years later for 22.8M, a 30% increase over Market Value. Could these inflated Market Prices be sustained when compared to the consistent depreciation in Market Values and volatile markets? Buyers were losing site of the fundamental that aircraft are depreciating assets.
In March 2000, the economy entered a recession when the Dot-com bubble collapsed and the NASDAQ crashed. This ended the longest economic expansion on record.
The Dot-com bubble was not the sole impetus for the recession. After September 2001, the Dow had its worse loss ever. WorldCom was the largest bankruptcy filing in US history and Enron filed in December 2001, taking down Arthur Anderson as well. From 2000 – 2003 Market Prices for business jets declined an average of 30% from their height 3 years earlier and nearly paralleled the decline and subsequent rise of the DJIA thru ‘07.
Is it plausible to benchmark the rise / fall of the business jet Market Price to the fluctuations in the Dow?
From 2003 – ‘07, economic growth was fueled primarily by the credit and housing bubbles, which turned out to be illusory. Credit expansion creates wealth and growth, but at the end of the cycle, it creates a bust. Subsequent to the crash of the NASDAQ in March ’00, GV Market Prices remained at a depressed level until 2003, thereupon following the financial markets to an all time high, only to collapse again in 2009, as a result of the recession starting in ‘07. Typically after a collapse, natural rebound occurs.
However, this recession is not like others: recovery is tied more to the problems in the structure of the economy rather than the ups and downs of a business cycle. What effect will the fundamentals of this recession have on the demand and pricing of business jets?
Business jet Market Prices are down 40% (+/-) from the height in 2008 and [on average] 15% below Market Value. Historically, recoveries in the business jet market have lagged economic recoveries by 18 months. If the current recovery started in the 3rd Quarter ‘09, the business aircraft market should recover in the first quarter of next year, but once again, this recession is not like others, there are different dynamics in play.
Historically, banks have loaned money to small / medium businesses when recoveries were underway. However, that is not happening this time. The ‘monetary easing’ has not translated into loans for business and the creation of jobs, both of which fuel economic activity and subsequently, new aircraft sales. Some OEMs have indicated that new business jet deliveries are projected to decline further, before starting a recovery in 2011. What impetus will drive the resurgence in sales?
In some areas of the world (i.e., China) restrictions have been lifted on the use / sale of aircraft and more banks have increased lending. But, how many aircraft can these countries support in the next 1 – 5 years?
Recessions are tough, but we can glean lessons and transform the way we do business. We keep hearing the ‘Great Recession’ is over, which is difficult to comprehend. The government’s official measure of worker underutilization more than doubled in this recession’s first two years, to 17+%. In other words, one in six is unemployed or working part-time. This excludes the overqualified who work one or two jobs at half what they earned before they got fired. The US has lost over 8.4 million jobs (and climbing) from Dec ’07 thru Mar ’09. It is difficult to comprehend a recovery with so many jobs lost.
The credit and house price explosion led to a building boom and then to a surplus of unsold homes. Easy credit, aggressive marketing from lenders and the belief that prices would continue to appreciate, encouraged borrowers to obtain adjustable rate mortgages. However, once the monthly payments reset, refinancing became difficult because house prices declined and the value was less than the mortgage, resulting in high foreclosure rates (similar to the aircraft industry). The key factors were lack of equity and speculation. Now, 4 million> existing homes are for sale, of which almost 3 million are vacant.
In 2005, the median down payment for home buyers was 2%, with 43% making no down payment at all (China has a 20%+ down payment requirement). By 2006 business jet sales were on the rise, with Market Price far exceeding Market Value once again. And similar to the real estate market, lenders were financing business jets near 100% of the selling price, with little regard for Market Value. For example, a 2003 G550 that sold new for 41M resold in 2007 for 52M, a near 30% premium. By comparison, a 2003 year model sold in 2009 for $33M. Consider the number of sales that were financed at Market Price, the number that had to resell for economic reasons in now depressed markets… Is there a corollary between the real estate and business jet markets?
We are about midway through the end of the subprime mortgage resets and approaching the second wave of resets with the ‘Option Adjustable Rate’ loans, which will begin in the 2nd quarter ‘10 through October ’11 and could be larger than the subprimes. The last time we went through such a reset we were at the top of the real estate bubble.
Up to 9 million more homes may enter foreclosure from 2009-2011, at an average cost of $50,000 per foreclosure. The IMF estimates cumulative losses of banks and other financial institutions could exceed $4 trillion globally.
Between June 2007 and November 2008, Americans lost more than a quarter of their net worth. By early November 2008 the S&P 500 was down 45% from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with future markets signaling a 30-35% potential drop.
The prosperity of a few years ago depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. Will the housing bubble return? It is difficult to embrace the optimistic predictions especially with the loss of so many jobs. Of critical importance is the need to focus on technology and manufacturing in the US vs. a service, consumption-based economy.
What is the next economic impetus? The giddiness of the recovering stock market makes it easy to overlook questions about the cause for its 70% increase since March. Was it a function of the zero interest loans to the banks? If the commercial real estate market craters because banks are not properly recognizing their losses, hundreds of regional banks, and Wall Street banks, could fail triggering a long-awaited correction in the Dow, creating more job losses and a deeper recession.
Corporations are sitting on a lot of money. However, until the skepticism recedes about the end of the recession, capital spending will be dormant. Some are using mergers and acquisitions as a primary means of growth because assets are relatively cheap. Does this stimulate or eliminate job growth?
So, how is the business jet market fairing today? Business jets are selling. In the medium and long range categories, 50% more aircraft were sold in 2009 than 2008. Although the majority are selling at an average 15% below Market Value or 50% less than Market Price at the height of the market. The majority of deals are foreign based. Could this be due to the weak dollar or fundamental need?
One way to bring some stability to the aircraft market is to first understand that, in our industry growth is tied to the global economy. However, business jets are depreciating assets, not commodities, and typically have a useful life of 30 years. From a very simplistic view, if we were to focus more on Market Values, when buying, selling, lending or upgrading, we could perhaps be on more stable footing during the economic swings.
For information or a discussion on valuations and long-term strategic planning, please call us in New York at 518-242-2400 or email our President, Dennis Rousseau, at email@example.com.