Aircraft Leasing: Investing Essentials

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The global airline industry has taken off in the last few years, driven by the worldwide economic recovery and the proliferation of budget carriers in the developing world. As a result, many airlines across the world are looking for airplanes to expand their fleets.

When airlines are unable or unwilling to acquire aircraft on their own (for reasons such as the availability of airplanes or credit), they turn to the aircraft leasing industry. Leasing companies have reaped a windfall fromthe rapid growth of the aviation industry, particularly from airlines operating in developing countries.

What is the aircraft leasing industry?
The aircraft leasing industry owns a large number and variety of aircraft, which are then leased to airlines. Commercial airplanes typically have a useful life of 20-30 years. However, airlines can't reliably project their aircraft needs that far into the future.

Aircraft leasing companies offer airlines an alternative to owning their own planes. Photo: The Motley Fool.

By contrast, aircraft leases usually run no more than 12 years (and often closer to three to seven years). Thus, leasing an airplane involves a much smaller commitment from an airline. In effect, aircraft lessors act as middlemen in the market, distributing planes to airlines that can operate them profitably over the course of their useful lives.

How big is the aircraft leasing industry?
In the U.S., most major airlines own the bulk of their fleets and are moving further in that direction . However, the aircraft leasing industry is still massive and growing thanks to strong demand from emerging markets.

As of 2011, six top publicly traded aircraft leasing companies in total owned nearly 4,000 airplanes valued at approximately $90 billion. Since then, the aircraft leasing market has continued to grow due to favorable market conditions.

How does the aircraft leasing industry work?
The aircraft leasing industry provides a number of services. First, airlines with limited access to credit can turn to this market to expand and modernize their fleets. Second, airlines that want to avoid the 25-year commitment of owning an airplane can instead lease planes. Third, if an airplane model is sold out for many years into the future, airlines can try to lease the plane rather than wait to buy it.

Aircraft leasing is a particularly big business in emerging markets. Photo: Volaris.

Aircraft leasing companies generally acquire airplanes in one of three ways. First, they may place orders for new planes directly with the manufacturers. Second, they may enter into sale-leaseback transactions with airlines that have already ordered planes. (In this role, aircraft leases become a substitute for debt financing.) Third, they may buy used aircraft.

In sale-leaseback transactions, the aircraft leasing company already knows which airline will lease the plane. Otherwise, these lessors rely on contacts with dozens of airlines in order to secure leases for the planes they have purchased.

As the initial lease term expires, the aircraft leasing company will often give the airline an option to renew the lease or buy the plane. If the airline is not interested in keeping the plane, the leasing company can either place it with a different customer or sell it.

Different aircraft leasing companies adopt different strategies for purchasing and selling aircraft. Some only buy new planes and sell them before they get too old. Others prefer to buy older planes at a discount and keep them through most of their useful lives. Some companies are more opportunistic and will buy both new and old planes.

What are the drivers of the aircraft leasing industry?
One key driver of the aircraft leasing industry is demand for new airplanes. With the global aviation industry expanding rapidly, many airlines are looking to get their hands on new planes. High oil prices are also driving replacement demand, as airlines retire old planes in favor of more fuel-efficient models.

A second key driver is the interest rate environment. The present low interest rate climate is great for aircraft leasing companies, because they generally carry large debt loads to finance their aircraft purchases. Lower interest rates thus mean lower costs.

The third key driver for aircraft leasing companies is the airlines' access to credit. Most U.S. airlines are buying an increasing proportion of their planes outright, as they are benefiting from the same low interest rate environment that is boosting aircraft leasing companies' profits.However, airlines with weak credit metrics and those in emerging markets tend to have trouble getting loans, no matter their situation. As long as air travel continues to boom in emerging markets, there should be plenty of eager customers to power the future growth of the aircraft leasing industry.

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The article Aircraft Leasing: Investing Essentials originally appeared on Fool.com.

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