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Innovative Revenue Strategies – An Airport Guide (2015)

Chapter: Chapter 5 - Airport Entrepreneurial Activity Part II

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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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Suggested Citation:"Chapter 5 - Airport Entrepreneurial Activity Part II." National Academies of Sciences, Engineering, and Medicine. 2015. Innovative Revenue Strategies – An Airport Guide. Washington, DC: The National Academies Press. doi: 10.17226/22132.
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5 1 Chapter 5 Airport Entrepreneurial Activity – Part II 5.1 Introducon 5.2 Revenue Parcipaon in Real Estate Development 5.3 Revenue Parcipaon in Mineral Estate Development 5.4 Wrap up 5.5 Addional References Chapter 4 described a revenue development strategy that involves airport provided services and shared use of services, facilies, and systems. Today, development of non aeronaucal facilies, such as a tenant logiscs and warehouse facility, is likely to involve an airport sponsor and other business partners. The queson remains, what is the best arrangement from the sponsor’s perspecve to maximize revenues and minimize risk? This chapter discusses ways airport sponsors can parcipate in real estate and natural resources development. The techniques presented in this chapter are applicable to many non aeronaucal development projects. 5.1 INTRODUCTION For airports with developable real estate, several methods can be used to (1) capitalize on their unique posion as transportaon centers and (2) maximize non aeronaucal revenue through real estate or mineral estate development. Collecng ground rent is the most basic and tradional approach to airport real estate development. However, innovave airport directors and business managers have structured other transacons to create new revenue sources, share profits, and further smulate economic development opportunies regionally. Chapter 8 of this Airport Guide presents two case studies of airports with markedly different circumstances that have acvely parcipated in real estate development. These two airports are Pisburgh Internaonal and McCarran Internaonal (Las Vegas) airports. Pisburgh provides an example of airport officials, faced with a stagnant real estate market, capitalizing on their airport’s presence and jumpstarng development acvies. By ulizing creave financing techniques, such as formaon of a tax increment finance (TIF) district, Pisburgh Internaonal’s Allegheny County Airport Authority (ACAA) convinced a well established local developer to construct a Revenue Participation in Real Estate and Natural Resource Development

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 2 speculave (spec) building on ACAA property. ACAA assumed some of the risk by converng a poron of the spec building’s ground rent to parcipaon in future building rents from subtenants. The spec building leased quickly, reflecng demand for office and industrial space in the area. Construcon of addional buildings followed. Acve development demands ensued, leading to mulple development projects, some of which connued to be built on speculaon. The Pi‹sburgh Internaonal Airport case study reflects how the use of creave structures and a willingness to accept some risk can smulate new development acvity and, thereby, create new revenue sources for an airport. McCarran Internaonal Airport iniated retail and commercial development projects at a me when the real estate market was robust. The airport’s sponsor, the Clark County Department of Aviaon (Aviaon Department), had acquired 5,226 acres of land from the Bureau of Land Management (BLM), pursuant to the Southern Nevada Public Land Management Act of 1998. Much of the land was located within the airport’s noise abatement zone. The Aviaon Department was able to sell, lease, or transfer land for fair market value and place deed restricons on its use. Acquision of the land presented an opportunity for the Aviaon Department to develop innovave projects. Creave parcipaon structures allowed the airport sponsor to earn revenues in excess of what might have been realized from ground rents. The approach required a risk tolerance not typically associated with airports owned by a municipality or county, but the inial phases of the program produced new and significant sources of commercial revenue for the airport sponsor. This chapter of the Airport Guide presents different ways that airport sponsors can partner with public and private companies to parcipate in real estate and natural resource development. Table 5 1 describes five ways that airport sponsors can parcipate in real estate or mineral estate projects. Table 5 1: Revenue Parcipaon Approaches to Real Estate and Mineral Estate Development Code Types of Revenue Parcipaon Descripon Finance & Property Management – FN FN 1 Parcipang Leases and Equity Parcipaon Sponsor swaps a poron of the ground rent in exchange for a share of future revenue streams. FN 2 Direct Ownership Sponsor acts as developer: plans, finances, constructs, and operates facilies. Profit or loss goes directly back to sponsor. FN 3 Public Private Partnerships (P3s) Sponsor grants a private enty the right to design, build, maintain, operate, or finance buildings or infrastructure. Many opons exist regarding division of responsibilies for construcon, financing, management, and payment to the sponsor who maintains ownership of the parcular asset. FN 4 Joint Development Similar to partnerships in that project parcipants may both help with the costs of development and share in the revenues. FN 5 Mineral Estate Parcipang Leases A potenally significant source of revenue that can come from upfront payment for exploraon acvies, producon royales, and land rent for surface acvity. Source: KRAMER aerotek inc., 2014

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5-3 These approaches apply to a wide variety of property development ac vi es. Figure 5-1 presents examples of facili es and mineral development for which an airport sponsor may consider project par cipa on beyond a tradi onal ground lease. Addi onal discussion about non-aeronau cal ac vity and facili es at airports also is available in addi onal ACRP publica ons, conference proceedings, and industry publica ons, several of which are included as references at the end of this chapter. Figure 5-1: Real Estate and Natural Resources with Potenal for Airport Revenue Parcipaon Source: KRAMER aerotek inc., 2014

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 4 5.2 REVENUE PARTICIPATION IN REAL ESTATE DEVELOPMENT This sec on describes and evaluates different ways that an airport sponsor can par cipate in non aeronau cal real estate development. FN 2: DIRECT OWNERSHIP Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges - Key Low Moderate High Not Relevant Overview Depending on the circumstances, direct ownership is a valid op on for considera on, whether in the context of real estate development, concessions, parking, mineral extrac on, or other capitaliza on of an airport’s assets. Direct ownership is a more risk inherent approach, no maŠer which airport assets are being considered for further development. Focusing on the development of land for commercial real estate provides a good illustra on of the considera ons that must be taken with the ownership op on. Direct ownership involves the airport sponsor assuming the role of developer and, therefore, the obliga ons and risks inherent in that role. The airport sponsor owns the en re project and receives all the profits. Should the project fail to meet projec ons, the airport sponsor assumes the losses of the failed project, as opposed to being a ground rent recipient. Given that most airports are not tax paying enterprises, such losses do not provide a tax incen ve to them, as they might to a tax paying private developer. The second significant risk is the financing. Should the project fail to generate sufficient cash flow to amor ze debt, the airport sponsor is responsible for all shor“alls. Addi onally, there is construc on risk. Depending on how the construc on contracts are dra”ed, the airport sponsor may be responsible for overruns on construc on costs. The reward for assump on of all these risks is the receipt of 100% of the profits of successful developments. Accordingly, solid financial forecasts are crucial to any analysis of the viability of a project to determine whether such profits are likely to be sufficient to make the risk worthwhile. Extent of Airport Use Direct ownership of any airport asset can be used by all airports to develop new sources of revenue. For example, airports with retail components, excess real estate, or natural resources, to men on a few,

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5 5 have the opon to operate businesses on their own or to contract with third pares to operate businesses based on these assets. Most airports contract out such operaons, but a few airports have begun operang these assets directly. Numerous examples exist of airports taking on direct ownership of various businesses outside of typical airport funcons. In 2010, Denver Internaonal Airport purchased 27 oil and natural gas wells on its property, which have been esmated at generang $3.5 million per year in revenue. PiŒsburgh Internaonal Airport owns and operates a jet bridge refurbishing business. Sarasota Bradenton Internaonal Airport operates a self storage facility. Implementaon The implementaon of ownership for any airport asset or operang component is similar to that of an equity parcipaon proposal.1 Because ownership risk in a project is much higher than the risk associated with a ground lease, however, a detailed risk reward analysis should be developed and discussed with the airport’s governing body so that the sponsor can make an informed decision whether to proceed. Significant staff me will be required to manage properes or businesses directly owned by the airport sponsor. O—en, hiring new employees who have experience in the type of business they will be operang will be required. If the business already exists at the me the airport takes over, it is reasonable to offer posions to the current employees. Significant addional resources will likely be required, whether it is simply building management or operaonal control. The airport should develop a business plan, as any for profit enterprise would, to achieve cost efficiencies like ulizaon of airport staff that may have excess capacity. Polical, Governance, and Legal Issues The most significant challenge of direct ownership will be countering resistance (including possible polical pressure) based on the private sector’s opinion that governmental enes should not compete with private sector enes. Nonetheless, the trend is growing for airports to undertake services and developments previously awarded to private operators or developers. If an airport can perform funcons more economically and effecvely than a private sector enty, then the airport should not be precluded from engaging in such acvies. The added compeon helps ensure that the private sector operates in a compeve and responsive manner to receive development and operang rights that are not awarded simply because of polical pressure. Addional issues with direct ownership and operaon of businesses may arise depending on the locaon and type of enterprise being contemplated by the airport. Such issues may require addional research. For example, airports considering using this technique are advised to ascertain the following: Whether state laws present any statutory impediments 1 In this context, equity parcipaon is when the airport invests in a real estate deal and in return acquires a percentage of ownership (equity) in the development project.

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 6 Whether federal funding is available for airport run operaons, if such funding is not available to the private sector Whether the airport sponsor’s operang businesses would lose tax exempt status FN 1: PARTICIPATING LEASES AND EQUITY PARTICIPATION Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges - Overview Real estate development by airports typically has followed a tradional model when leasing land for commercial development. This opon involves a ground lease for a set limit term and a ground rent calculated using the real estate’s appraised value. Although this approach offers the airport a steady and predictable rent stream, any opportunity to share the more lucrave building rent is le† exclusively for the developer. When an airport sponsor is taking no risk in a development project, the tradional ground lease approach is appropriate. However, entrepreneurial airport sponsors that are willing to assume some development risk have the opportunity to enhance cash flow from development projects by contribung the land for a ground rent and retaining an equity stake in the developed property. Contribung an asset (such as land) in exchange for equity is referred to as equity parcipaon. Alternavely, an airport sponsor could exchange a poron of the ground rent for a share of future building rents received. Reducon or eliminaon of ground rent in exchange for a share of building rent is executed through a parcipang lease. This arrangement may take the form of a pre negoated flat rate for building rent (e.g., $4.00 per square foot) or a share of the project built into the lease rate (e.g., 50% of rent in excess of $10.00 per square foot). Extent of Airport Use Given that both parcipatory leases and equity parcipaon are primarily ulized for real estate transacons, the use of this technique is limited to those airports that have developable property. Airports whose enre land mass is occupied by aviaon operaons have no room for further development. On the other end of the spectrum, large hub airports and small general aviaon airports “The Sarasota Manatee Airport Authority negoated with a developer for a mixed use development. The parcel was divided into pieces, with incenves for a full build out of the land. With the first parcel, the developer got a standard 30 year lease. With each addional piece, the enre developed parcel would add incremental increases in years on the lease. A hotel was built first, and its presence raised the value of other land around the parcel. The Authority iniated a pilot program that included ground rent from the land and a percentage of gross revenue on any food sales. The revenue parcipaon program has been very successful.” — Fredrick (Rick) Piccolo, President and CEO, Sarasota Bradenton Internaonal Airport

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5 7 may have acreage available for further development. Colorado’s Centennial Airport, as well as Dallas/Fort Worth Interna‡onal, Denver Interna‡onal, Edmonton Interna‡onal, El Paso Interna‡onal, Piˆsburgh Interna‡onal, Rickenbacker Interna‡onal, and Salina Municipal airports, are excellent examples of airports with extensive land acreage available for development. Un‡l now, the prevalence of these arrangements also has been limited by most airports’ non ac‡ve and risk averse approach to real estate development. Airports that engage in par‡cipatory leases include McCarran Interna‡onal, Piˆsburgh Interna‡onal, and Sarasota Bradenton Interna‡onal. Implementaon Implemen‡ng the restructuring of an airport’s lease nego‡a‡ons and, most crucially, involving contribu‡ons of land, first requires “buy in” or approval by the airport’s governing body. Therea•er, it becomes a maˆer of nego‡a‡on with the airport business office and legal counsel charged with nego‡a‡ng business transac‡ons. Those individuals will be required to develop forecasted financial statements to indicate the poten‡al and most likely investment return over a 5 10 year period. To measure the economic impact on the airport, the analysis must compare fixed ground rent to a sharing arrangement. Polical, Governance, or Legal Issues One addi‡onal benefit of a revised leasing strategy is that there are few impediments to its implementa‡on. The airport’s governing body needs to approve the transac‡on(s), but few other approvals are required. FAA may provide input on lease terms to ensure that the airport is receiving fair market value for its contributed land or par‡cipa‡on in the sublease revenue stream and to confirm that other grant assurances will not be violated. As long as all of the revenues derived from these arrangements remain with the airport, there should be no viola‡ons of bond ordinances or any triggering of a revenue diversion issue. It is incumbent upon the airport to partner with the right developer. The developer needs to have sufficient liquidity and net worth to ensure comple‡on of a project. From the airport’s perspec‡ve, this is not qualita‡vely different from simply ground leasing the property to a developer; however, the level of risk is slightly higher for a par‡cipatory lease, and the airport should be even more diligent in its inves‡ga‡on of the developer. One cau‡onary note is that most experienced real estate developers will form special purpose en‡‡es (SPEs) to engage in a project. Doing this is an aˆempt to limit the developer’s liability with respect to their equity in the project. The airport should require minimum capitaliza‡on of the SPE at an acceptable level and appropriate bonding to ensure comple‡on of any project. Indemnifica‡ons from an undercapitalized SPE are not worth anything more than what the SPE owns, so a guarantee from either a financially stable parent company or another form of security should be obtained. Poli‡cal considera‡ons may include pressure placed on the airport by highly placed elected officials or others to select a par‡cular partner.

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 8 FN 3: PUBLIC PRIVATE PARTNERSHIPS (P3s) Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges - Overview Public private partnerships (P3s) take many forms. A common example involves a private operator, typically supported financially by an investment bank or pension fund, bidding for control of certain assets (e.g., parking facili†es) of a public enterprise. The bidder calculates a net present value for the assets to be acquired and enters into a long term lease with the public enterprise (e.g., the airport sponsor). The lease term must be sufficiently long to allow the bidder to amor†ze the upfront payment in full and enjoy a reasonable rate of return. Due to the reliability of the cash flow and the more favorable rates of return, P3s have become popular with pension and insurance funds. Extent of Use Although FAA has an established pilot program for airport priva†za†on, the concept of total airport priva†za†on as a new revenue and opera†on model is not expected to take hold in the United States in the near future.2 Priva†za†on is the more established business model for many overseas airports. Priva†za†on of components of the airport is an op†on available to any airport that has a source of non avia†on recurring revenue. The lease of assets may entail a lump sum payment or some form of revenue sharing throughout the term. Subject to the nego†ated lease terms, opera†onal control is usually ceded to the bidder or its designee. P3s may also take the form of a joint venture, par†al priva†za†on or both. Implementaon Implemen†ng any level of priva†za†on is much more involved than the other techniques described previously in this Airport Guide. The process may entail the reten†on of an investment banker to assist in valuing assets, analyzing proposals, making recommenda†ons to enhance marketability and iden†fying the market of poten†al partners. The process varies depending on the assets proposed for a P3 transac†on. Once that process has been completed and a decision to move forward has been made, an extensive request for proposal (RFP) process is undertaken to iden†fy the best partnering op†on and to nego†ate a deal. Depending on the airline opera†ng agreement in place for a par†cular airport, airline approval may be required. In the event that assets acquired with federal funds are involved, FAA approval may also be 2 Currently, two airports par†cipate in the FAA priva†za†on program: Airglades Airport (2IS) in Clewiston, Florida, and Louis Munoz Marin Interna†onal Airport (SJU) in Puerto Rico. Stewart Interna†onal Airport par†cipated in the program from March 2000 to October 2007, but is now operated by the Port of New York and New Jersey. Seven addi†onal airports applied to par†cipate in the program, but subsequently withdrew applica†ons.

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5 9 required. Finally, and arguably most significantly, bondholder approval will need to be obtained for any assets covered by outstanding bonds. Each of the foregoing interested groups will likely also seek input into how proceeds from a P3 transac‡on will be u‡lized by the airport. Polical, Governance, and Legal Issues Depending on the airport’s governing body, any level of priva‡za‡on may require public support. Priva‡za‡ons, whether par‡al (e.g., an opera‡ng component of the airport) or total, generate strong public sen‡ment if the priva‡za‡on extends to businesses that interact with the public. Parking again offers a good example. Although priva‡za‡on may bring the implementa‡on of new technologies and efficiencies, in many instances there may also be impacts on pricing models—which in turn generates strong public reac‡on. In the public’s view, airports belong to the taxpayers, whether or not they have been funded en‡rely with bonds and Department of Transporta‡on funds. The con‡nued belief that taxpayer dollars fund airports provides the public with a pla”orm from which to claim a say in priva‡za‡on decisions. This places poli‡cal pressure on the elected officials—who o•en are responsible for appointment of airport management or oversight boards—to react accordingly. As noted above, other stakeholders (bondholders, airlines, FAA) have an interest in any priva‡za‡on proposals. If the funds raised from any priva‡za‡on proposal do not go to the airport sponsor, then the airport has the op‡on to not consider the proposal. FN 4: JOINT DEVELOPMENT Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges - Overview Joint development projects share many a˜ributes with par‡cipa‡ng projects, including par‡al priva‡za‡ons. Joint ventures are similar to partnerships formed for a single purpose, albeit without the formal legal structure inherent in a partnership. In a typical joint venture, the partners make their respec‡ve contribu‡ons to the venture based on their exper‡se or ability to provide property or capital. In the context of an airport, the airport controls unique assets that may be contributed to a venture, whereas the co venturer brings capital and exper‡se to capitalize on a revenue opportunity. An example is a contribu‡on of land by an airport to be developed by the co venturer, who provides all of the exper‡se of a real estate developer to create a joint development, with revenues shared based on a pre nego‡ated split. An example of a joint venture not based on real estate is a master concession arrangement, such as the opera‡on of an airport’s retail facili‡es or air mall. Once again, the airport controls and contributes the retail opera‡ng component of the airport to an experienced operator, who brings leasing exper‡se,

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 10 Denver Internaonal Airport (DIA) has oil and gas development and acve agriculture on the airport. It also owns subsurface water rights. DIA owns the mineral rights on all of its 34,000 acres, but leased approximately 27,000 acres to Petro Canada Resources (PCR) for oil and gas exploraon. In 2010, PCR planned to divest its U.S. upstream oil and gas assets. DIA exercised its first right of refusal to buy back PCR assets on the airport property. As a result, the airport has more than tripled its original investment in the mineral rights re purchase. DIA also has water rights. The airport does not own surface water, but owns subsurface water (approximately 26,000 acre feet). The airport has no current plans to moneze its water rights. DIA also leases land for farming; however, agriculture is used primarily for cost avoidance. Currently 25,000 acres are farmed, mostly by farmers on the land acquired prior to the airport’s opening in 1995. The airport collects several hundred thousand dollars per year in cash rent and restricts what can be planted on airport land. This conforms to the airport’s wildlife migaon plan. If the airport had to maintain the land, it would cost $6 or $7 million to remove noxious weeds and wildlife a—ractants. – John Ackerman, Chief Commercial Officer, Denver Interna onal Airport capital improvements, and operaonal enhancements for a percentage of the gross revenues generated. Extent of Airport Use Joint ventures offer a business model that is quite common in the private sector. There is no reason why this model would not provide a reasonable means of increasing revenues through shared parcipaon at an airport. Polical, Governance, and Legal Issues Some characteriscs of joint developments overlap with characteriscs of other opportunies described thus far in this chapter. Accordingly, they involve similar challenges. However, the joint development concept provides enough disnguishing aspects that the challenges discussed in relaon to iniaves such as direct ownership should be easier to address. Specifically, because the private sector is a parcipant in joint developments, claims of unfair compeon are not significant. Furthermore, since the iniave does not involve privazaon in the strictest sense, the airport maintains more control. 5.3 REVENUE PARTICIPATION IN MINERAL ESTATE DEVELOPMENT Overview Non aeronaucal revenue generaon is highly dependent on special situaons. Many of the naon’s busiest airports have li—le or no land unoccupied by terminals, consolidated rental facilies, parking lots, and other dedicated airport uses. However, some airports have significant surplus property that is not dedicated to airport operaons and, therefore, can be used for real estate development and other non aviaon revenue generang acvies. Airports that sit on such landmasses also may have the opportunity to develop mineral estates and other natural resources that, in many instances, have proved to be a significant revenue source. Such resources include minerals such as oil, gas, and coal, but could also include water, mber, and similar natural resources.

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5 11 FAA has determined that revenue derived from the sale of an airport’s natural resources constutes “airport revenue.”3 Therefore, it is subject to the revenue diversion rules requiring that such revenue be ulized only at the airport [see Grant Assurance 25 as to permiŽed use of Airport Revenues]. Although a sponsor municipality may claim ownership of the airport’s natural resources, that claim has limited relevance in that the revenues from the sale of such resources must remain with the airport for airport uses. The method for generang revenue from these resources varies depending on the type of resource that the airport sponsor wishes to exploit. For example, coal and mber are usually sold based on the highest and best bid. Because of the experse that may be required to extract and market such resources, however, the airport may limit the number of bidders by first undertaking a request for qualificaons (RFQ). The RFQ allows the airport to prequalify companies that may be eligible to bid for the applicable resource. For example, the extracon of coal requires that the extracng company have: (i) experience in strip and deep mining; (ii) sufficient financial net worth to ensure that the property can be restored to its pre extracon condion; (iii) adequate insurance to cover claims that may be made in connecon with injuries arising during the process; and, to the extent that royales may be involved, (iv) sufficient market presence to ensure the maximum price for the sale of coal to the end users. These agreements are typically for a term sufficient to extract the coal deposits, but should be terminable by the airport sponsor in the event of nonproducon or if the airport needs the property for other purposes, especially aeronaucal purposes. FN 5: MINERAL ESTATE PARTICIPATORY LEASES Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges - Bonus Payments, Royales, and Surface Rights A royalty paying oil and gas lease is typically the governing document for oil and gas exploraon on airport property. With the advent of horizontal drilling4 and the discovery of new major shale deposits, natural gas exploraon has presented a major revenue opportunity for airports that have shale deposits and the ability to access them. The revenue stream from oil or gas exploraon acvies is two fold in that the exploraon company pays a significant upfront bonus payment (in the case of Dallas/Fort Worth Internaonal Airport, $10,000 per acre) and then a royalty on connuing producon. Gas, like coal, is very market driven. If 3 Per 64 Fed. Reg. 7696, at 7716, airport revenue includes revenue received “(iii) For the sale of (or sale or lease of rights in) sponsor owned mineral, natural, or agricultural products or water to be taken from the airport.” 4 The FAA requires clearance if horizontal drilling occurs under airfields, terminals, or other aeronaucal assets. In a horizontal drilling process, a well is turned horizontally at depth. This technique is normally used to extract energy from a layer of shale rock.

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 12 gas prices fall below a certain dollar amount, companies may find it more economically viable to cap a well and cease produc€on for the period of €me that the market is depressed. In order to ensure that the landowner—in this case the airport—is not harmed by such capping ac€vity, it is necessary to include a con€nuing produc€on clause requiring the driller to con€nue drilling for as long as a well is producing in certain paying quan€€es. The remedy for ceasing produc€on is a termina€on of the lease, which leaves the airport with the bonus payment originally paid for the right to receive the drilling contract and the airport is free to enter into a similar arrangement with a new driller. The typical lease term for an oil and gas lease is five (5) years with a con€nua€on provision that allows the driller to maintain its leasehold interest provided it con€nues to drill. It is also important for the airport to ensure that drilling ac€vity will begin by a predetermined date, taking into considera€on the environmental approval process, land prepara€on, and other ac€vi€es that need to be undertaken prior to sinking the first well. Two years should be more than sufficient €me between the lease award and commencement of drilling. Grant Assurance 24 requires the airport to obtain fair market value for all of its leased assets.5 Therefore, it is impera€ve that the airport calculate the surface rent for the land used for well pads or pipelines. The airport earns addi€onal revenue from land rent charged to the driller to ensure recovery of surfaces granted to the driller to access sites, lay out well pads, and install pipeline. Some of these revenue genera€ng ac€vi€es may not be available in gas leases with smaller acreage (e.g., a couple of hundred acres). For airports that have larger land masses, however (such as Dallas/Fort Worth Interna€onal, Denver Interna€onal, and Pi‘sburgh Interna€onal), the lease becomes more valuable and the airports have a greater bargaining posi€on when nego€a€ng terms. The royalty revenue provides the airport with a con€nuous revenue stream for as long as gas is being produced and marketed. Careful deal structuring is required to ensure that the royal€es are not net of costs associated with produc€on, permi“ng, transpor€ng, processing, storage, marke€ng, taxes, or other costs. Moreover, it must be remembered that first and foremost, the airport is dedicated to airport opera€ons. Therefore, any lease or agreement for extrac€on of mineral resources should include language that subjects all such ac€vity not only to applicable laws and environmental regula€ons, but to airport regula€ons as well. This may affect such items as well spacing, controlled access by drilling companies’ personnel, and the airport’s right to suspend opera€ons, among other things. Performance Security Significant performance security in the form of a surety bond, le‘er of credit, or similar security should be obtained to ensure that, at the end of the lease term or well abandonment, the driller removes all equipment and undertakes the proper abandonment process as may be required by the applicable 5 Grant Assurance 24 states that a sponsor will maintain a fee and rental structure for facili€es and services, which will make the airport as self sustaining as possible.

CHAPTER 5 – AIRPORT ENTREPRENEURIAL ACTIVITY – PART II 5 13 state’s regulatory agency. Addionally, adequate insurance and security is necessary to secure any indemnificaon to which the airport may be entled for damages arising out of fires, accidents, polluon, or other causes that might be brought about by a company’s operaons on airport property. Ownership of Subsurface Mineral Estates Issues regarding ownership of mineral estates go beyond the potenal claims by sponsoring municipalies. Title to mineral estates may not always follow tle to property surface rights. Unl fairly recently, it was not unusual for deeds transferring property to reserve the rights to mineral estates. To make maˆers more complicated, such reservaons of rights vary significantly from deed to deed and from jurisdicon to jurisdicon. Such reservaons may include gas tle for a period of 5 years or for as long as the property wells are acvely producing. Ownership of the airport surface rights alone is not definive as to the ownership of the mineral rights, even with sustained airport operaons for a significant historical period. In order for the airport to exploit the minerals on its property, it may be necessary to engage inmineral estate condemnaon.6 Whether it is operated by an authority or by the municipality in which it is located, the airport has condemnaon power to be able to transfer and then secure tle to the mineral estates. However, once condemned, the condemning power must pay “equitable just compensaon,” which is usually based on the valuaon of the mineral estates condemned. In some instances, mineral estates may have no value if they cannot be praccally or commercially obtained and ulized. A significant example of this is shale gas, which had no value prior to commercializaon of current hydraulic fracturing (fracking) acvies. However, over the past 20 years, technological advances in the industry have created significant value in those same mineral estates. Title to mineral estates must be clearly established for the airport landowner to be able to sell or lease those assets. Exploraon companies want to ensure that they have the absolute rights to the minerals for which they are paying significant dollars. The typical gas lease includes a holdback or escrow of amounts necessary to cover quesons as to tle. Establishing clear ownership of tle is laborious and can require searches back to the first deed on the property, in some cases as early as the early 1800s. Protecon for Airport Financial and Aeronaucal Interests Mineral estates may be appraised. Appraisal companies that specialize in specific resources (i.e., water, mber, oil, gas, coal) are able to give airports a reasonable expected valuaon of the mineral estates. For any on going mineral estates royalty revenue, the contracts granng rights to third pares should include audit rights allowing the airport to confirm that it is receiving all of the royalty revenue to which it is entled. Typical penales for understatement of royales would include recovery of the cost of any audit plus a penalty of 5% of the understatement. When structuring agreements with connuing site ingress and egress by a mineral estate purchaser or lessee (whether for drilling, excavaon, harvesng, surface operaons, or other acvity), acvity should 6 The transfer of property tle under the power of eminent domain.

INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE 5 14 be limited to designated porons of the airport that are not planned for development pursuant to the airport’s master plan. FAA Regulaons (FARs) specify that “Part 77” surfaces must be protected, and any lessee’s operaons should be restricted to prevent interference with the airport’s use of the airport, whether for its aeronaucal or commercial development acvity.7 Unrestricted access of personnel also is problemac, and controls need to be in place to ensure no violaons of security procedures or FAA or TSA rules and airport regulaons. Furthermore, the airport should maintain the right to relocate operaons to ensure that the airport maintains flexibility in its connued development plans. Because of the risks associated with mineral estate exploraon and exploitaon on airport land, it is also important for the airport to consider the types of indemnificaon and insurance requirements to be imposed upon drilling firms. Based on each airport’s parcular circumstances, the airport should determine what types of coverage and limits it would impose, as well as its willingness to allow for self insured limits depending on the financial strength and creditworthiness of the contracng party. 5.4 WRAP UP Flexibility in various real estate and mineral estate development techniques will provide airports new opportunies to enjoy a greater share of revenues. Each such technique is weakened by various degrees of risk; therefore, it is imperave that airport management analyze the risks of each technique to determine whether the risk is at an acceptable or unacceptable level and respond accordingly. Such analysis should include development of an understanding as to how such risks may be migated or minimized. There may be legal or polical implicaons or challenges to each technique discussed herein, which would have an impact on an ulmate determinaon. Although issues invariably arise with any a–empt to find ways to maximize non aeronaucal revenue, most of those issues can be addressed. Airports need to focus on developing such revenues as funding connues to shi— away from strict reliance on governmental grants and airline fees. Nearly all federal funding is increasingly the subject of scruny as polical des move to curb spending. Likewise, pressure on airline profitability (such as rising fuel costs) means that even small budget items, like enplanement costs, will need to be managed. Development of airport resources and land will help to ensure the airport remains compeve and is able to afford connued growth and enhancements. To the extent that quasi public enes, such as airport authories, provide more flexibility in undertaking such iniaves, it is advantageous for local municipalies to explore whether their municipally operated airport would be be–er served by implemenng such techniques. Table 5 2 summarizes the revenue parcipaon approaches presented in this chapter. 7 FAR Part 77 establishes standards for determining obstrucons off runways in navigable airspace.

Table 5 2: Approaches to Revenue Parcipaon Code Approaches to Revenue Participation Extent of Airport Use Revenue Potential Airport Assumption of Risk Capital Required Complexity to Implement Political & Institutional Challenges Finance and Property Management – FN FN-1 Participatory Leases and Equity Participation - FN-2 Direct Ownership - FN-3 Public-Private Partnerships - FN-4 Joint Development FN-5 Mineral Estate Participatory Leases - Source: KRAMER aerotek inc., 2014

5.5 ADDITIONAL REFERENCES KRAMER aerotek inc., ACRP Synthesis 19: Airport Revenue Diversificaon, Transporta on Research Board of the Na onal Academies, Washington, DC, 2010 LeighFisher, Kaplan Kirsch & Rockwell LLP, and LeighFisher/Eno Transporta on Founda on, ACRP Report 66: Considering and Evaluang Airport Privazaon, Transporta on Research Board of the Na onal Academies, Washington, DC, 2011 5 16 INNOVATIVE REVENUE STRATEGIES – AN AIRPORT GUIDE

Next: Chapter 6 - Value Capture and Other Innovative Financing »
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TRB’s Airport Cooperative Research Program (ACRP) Report 121: Innovative Revenue Strategies – An Airport Guide describes a broad range of tools and techniques to improve airport revenue streams, recover costs, and achieve operational efficiencies. The report identifies customer needs; airport-provided services and shared services, facilities, and equipment; revenue participation in real estate and natural resource development; value capture and other financing opportunities; and improvements to existing airport businesses.

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