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

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29 4.1 Introduction By conducting a thorough analysis of applicable FAA guidance and policies (see Chapter 3), it becomes eminently clear that federally obligated airports need to fully understand the compli- ance issues associated with estimating market value and establishing and adjusting market rent for aeronautical and non-aeronautical uses. In addition to the associated compliance issues, the airport sponsor, airport management, and airport property managers—as well as indus- try practitioners—need to understand the most appropriate options and related processes for estimating market value and establishing and adjusting market rent for aeronautical and non- aeronautical uses. While FAA guidance and policies discuss appropriate options (as outlined in Section 2.4 pertaining to historic cost valuation, direct negotiation, and objective determination of fair market value), it is important to determine which is most appropriate for each situation. In this report, the objective determination of market value (and the associated property and airport characteristics) is analyzed. Additionally, federal guidance may require a specific analysis to be conducted. For example, non-aeronautical market value or market rent must be determined through an appraisal process. The underlying transaction (purchase or lease), type (aeronautical or non-aeronautical), use (commercial, non-commercial, not-for-profit, or agriculture), basis (wholesale or retail), and lease structure (triple net or gross) will impact which approach is chosen as most appropriate for the objective determination of fair market value (or rent). Further, it is important to under- stand when (and by which mechanism) it is most appropriate to adjust rental rates throughout the term, as well as the impacts of reversion at the end of the term. Reversion plays a significant role in the case of an amortization schedule that surpasses the end of the term. As outlined in Sections 4.2–4.4, implementation of a logical process will ensure the most appropriate conclusion applicable to the given situation. As an introduction to these sections, Figure 4-1 outlines the process which will be fully described throughout this chapter. 4.2 Decision Framework As the airport sponsor, airport management, and airport property managers begin to consider the options for each situation, certain overarching concepts that will impact the framework of each process need to be understood and outlined. First, the highest and best use of the air- port land and/or improvements needs to be considered. While the concept of highest and best use is most often associated solely with an appraisal process, this concept ultimately impacts the decision framework for any analysis of airport land and/or improvements. Additionally, C H A P T E R 4 Estimating Market Value and Establishing Market Rent

30 Estimating Market Value and Establishing Market Rent at Small Airports a determination must be made if and when it is appropriate to compare airport land and/or improvements (aeronautical or non-aeronautical) with off-airport properties, as well as to the underlying approach (component or blended approach). Highest and Best Use A highest and best use analysis, as a condition of an appraisal and conducted by an appraiser, is intrinsically tied to the definition of market value. However, this type of analysis can find application in many different types of opportunities pertaining to airport land and/or improvements. For this report and as defined by the Appraisal Institute, highest Figure 4-1. Overview of process outlined in Chapter 4.

Estimating Market Value and Establishing Market Rent 31 and best use is—when appraising the market value of real property—the “reasonable, probable, and legal use of vacant land which is physically possible, appropriately supported, financially feasible, maximally productive, and results in the highest value.” From a different perspective, highest and best use has been discussed as the most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future. However, the highest and best use analysis (as outlined in this chapter) must con- sider the legally permissible uses, which will be impacted if the specific airport property under analysis is federally obli- gated. Additionally, the highest and best use analysis should be conducted within the context of either aeronautical or non-aeronautical use. In estimating highest and best use of the site as vacant and as improved, the uses are submitted to four different analyses: • Physically possible—which uses are physically possible on the subject site; • Legally permissible—which of the physically possible uses are legally permissible by current or probable zoning and deed restrictions on the subject site; • Financially feasible—of the selected uses based on the prior criteria, which uses will produce a net return to the owner of the site; and • Most profitable—which of the economically feasible uses provides the highest net return or the highest present worth. The four analyses are first applied to the subject airport land as if vacant and ready for development and then to the existing improvements (if applicable). However, the highest and best use of land if vacant and available for use could be different from the highest and best use of improved land. This will be true when the improvement is not an appropriate use and yet contributes to the total property value in excess of the value of the site. When conducting a highest and best use analysis, some of the key factors to consider are • Economic potential • Qualitative values (social or environmental) • Factors affecting land use such as – Zoning – Physical characteristics – Private and public uses in the vicinity – Neighboring improvements – Utility services – Access – Roads – Locations While the USPAP requires an appraisal to state the highest and best use of the subject land and/or improvement, this analysis also finds application when establishing market rent. When establishing market rent, it is appropriate to analyze each improvement based on the highest and best use rather than the existing use. For example, if an office is utilized for storage, a highest and best use analysis would dictate an office rental rate, which is typically higher than a storage rental rate. Significantly, this highest and best use analysis finds application for all aeronautical properties, with the exception of using aeronautical improvements (e.g., T-hangar) for non-aeronautical use. The highest and best use determination is the key to any appraisal report. As most airport managers know, highest and best use is not only determined by the market, but also the parameters of the Airport Layout Plan, the political situation regard- ing any airport facility, and the operational capabilities of the airport itself. Win Perkins, CRE Airport and Aviation Appraisals, Inc. One Airport Value Will Not Fit All Airport Tenants

32 Estimating Market Value and Establishing Market Rent at Small Airports As stated in the FAA Policy on the Non-Aeronautical Use of Airport Hangars, a non-aeronautical market rent must be established for non-aeronautical use of hangars. Utilization of Off-Airport Properties The process of estimating market value or establishing and adjusting market rent will be impacted by the underlying use of the property being analyzed (aeronautical or non-aeronautical). Before the process is initiated, agreement should be reached on whether to utilize off-airport properties in the analysis. When estimating market value or market rent for land used for aeronautical purposes, utilization of off-airport properties is highly problematic owing to the different types of land use. In the event off-airport properties are utilized, the adjustment between off-airport properties and on-airport, aeronautical properties would have to reflect that these land uses do not exhibit the same bundle of rights. It is difficult, if not impossible, to determine the adjustment applied to unencumbered off-airport value or rental rates to reflect the constraints imposed by the FAA, the airport sponsor, and others pertaining to the devel- opment and use of on-airport, aeronautical properties. Conversely, on-airport, aeronautical properties provide access to and use of the aeronautical infrastructure (i.e., runways, taxiways) that off-airport properties do not. Utilization of only aeronautical rental rates to support estimating market value or estab- lishing and adjusting market rent for other aeronautical properties is also consistent with FAA guidance. Order 5190.6B, Airport Compliance Manual, states that “in the view of the various restrictions on use of property on an airport (i.e., limits on the use of airport property, height restrictions, etc.), appraisers will need to account for such restrictions when comparing on- airport with off-airport commercial non-aeronautical properties in making fair market value determinations.” As stated in Compliance Guidance Letter 2018–3, Appraisal Standards for the Sale and Disposal of Federally Obligated Airport Property, “it is highly recommended for determining FMV [fair market value] rates [i.e., market rent] that aeronautical property is compared to other aeronautical property serving the same function at similar airports throughout the region or state.” There may be instances when utilization of off-airport properties to estimate market value or establish and adjust market rent is appropriate. The key example pertains to estimating market value or establishing and adjusting market rent of on-airport, non-aeronautical properties. When this occurs, it is appropriate to make an adjustment that reflects the difference in the bundle of rights. For example, the following should be considered: • Off-airport property is owned fee simple whereas on-airport property is leased. • Additional constraints are applied to on-airport property (14 CFR part 77, FAA and air- port sponsor rules and regulations, etc.). However, the analysis should include consideration of how the location of the airport land and/or improvements may provide enhanced exposure or access. Component or Blended Approach Aeronautical properties are highly specialized in their construction, size, and use. Consistent with the most recent guidance from the FAA in Compliance Guidance Letter 2018-3, Appraisal Standards for the Sale and Disposal of Federally Obligated Airport Property, market value should be estimated and market rent should be established as “compared to other aero- nautical property serving the same function.” For this purpose, it is recommended that each component of the subject airport land and/or improvements be analyzed based on the highest and best use of each component. This approach is consistent with current guidance to analyze

Estimating Market Value and Establishing Market Rent 33 each individual component based on “other aeronautical property serving the same function at similar airports” versus analyzing the subject airport land and/or improvements on a blended approach (analyzing the entire leased premises as one unit). As it pertains to aeronautical improvements, the components may consist of apron (asphalt or concrete), tiedowns, vehicle parking, terminal (used for general aviation purposes), office, hangar (community, executive, T-hangar, shadeports), shop, and storage. 4.3 Estimating Market Value and Establishing Market Rent Following completion of the decision framework (i.e., highest and best use analysis, utiliza- tion of off-airport properties, and component or blended approach), the methodology utilized to estimate market value or establish and adjust market rent must be addressed. As outlined in Chapter 2 of this report, the FAA Policy Regarding the Establishment of Airport Rates and Charges indicates 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—While historic cost valuation is an acceptable methodology to establish market rent from the FAA’s perspective (and predominately finds application at air carrier airports), this approach may not necessarily be consistent with the realities of the prevailing market for small airports. Additionally, the purpose of this report is to identify characteristics of airport property, which may have specific regional or location challenges for consideration when estimating market value and establishing market rent. As such, historic cost valuation has not been examined further. • Direct Negotiation with Aeronautical Users—As stated in Chapter 2, 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. However, to ensure both parties are acting knowledgeably as it pertains to market value or market rent, an underlying objective analysis is imperative. A survey con- ducted specifically for this report indicated that participants (consisting of airport property developers, airport property real estate agents, airport property lessees, and airport manage- ment representatives) believed an appraisal or comparable rent analysis should be conducted to determine the initial rental rate structure before initiating negotiations. Therefore, Chapter 6 of this report discusses a best-practices approach for negotiation of development and lease agreements (with the support of an objective analysis). • Objective Determination of Fair Market Value—While the FAA provides ample latitude to airport sponsors regarding the methodology used for estimating market value and establish- ing market rent, the FAA states that the methodology used should be objective. Therefore, an objective determination of fair market value is typically reached through an appraisal, and market rent is established through a comparable rent analysis. A survey conducted specifically for this report showed that the majority of participants identi- fied an appraisal or comparable rent analysis as the preferred method to estimate market value or establish market rent (Figure 4-2). Therefore, the appraisal process is examined from the dual perspectives of estimating market value and establishing market rent. Conversely, the compa- rable rent analysis is examined from the perspective of establishing market rent only. Consistent with industry practices, a competitive process has also been examined from an establishment of market rent perspective. While not directly identified by the FAA in the Policy Regarding the Establishment of Airport Rates and Charges, a competitive process utilizes

34 Estimating Market Value and Establishing Market Rent at Small Airports direct market forces through a proposal to determine the demand in the market and ultimately as a methodology to establish market rent. Airport sponsors are encouraged to determine if and when a competitive process is most appropriate for leasing land and/or improvements at the airport. The competitive process as well as appraisal and comparable rent analysis are discussed in the following. Competitive Process A competitive process is used to seek competitive proposals from qualified entities when land and/or improvements are available for occupancy or use. Essentially, this structured process includes advertising an opportunity, responding to questions about the opportunity, and evaluat- ing information received to permit the provision of services or leasing land and/or improve- ments. Airports often use competitive processes to secure FBO and SASO products, services, and facilities and to develop and lease land and/or improvements. Consistent with industry percep- tions, a competitive process is often best suited for high-demand environments in which multiple parties have implied or expressed interest in specific airport land and/or improvements. Airport sponsors utilize competitive processes to determine who is best qualified for or suited to develop land, occupy improvements, or conduct aeronautical or non-aeronautical activities at an airport. It should be noted that the selection can be based on a multitude of factors ranging from experi- ence to financial capabilities to revenues generated for the airport sponsor. Competitive processes typically include one or more of the following: request for information (RFI), request for qualifications (RFQ), or request for proposals (RFP). However, in each case, the opportunity should be appropriately advertised for the given situation. For example, an FBO opportunity in a high-demand market may warrant national advertisement, while vacant land at a small, low-demand general aviation airport may be appro- priately advertised in local, state, or regional publications. Each aspect of a competitive process is typically conducted for different purposes at small airports, which may or may not impact the establishment of market rent. First, an RFI can be utilized to gauge the level of interest for the available airport land and/or improvements. An RFQ provides an opportunity for parties to express interest and demonstrate qualifications. However, an RFI or RFQ process (outside of a negotiation) will typically not result in the establishment of market rent. 38% 36% 17% 9% Appraisal Comparable rent analysis Negotiation Other Figure 4-2. Preferred methodology to determine market rent. While the competitive process is consistent with FAA guidance, RFPs in highly competitive situations could result in inflated offers (above-market rent) to secure the opportunity. However, it is necessary to understand the historical aspects of any market transaction when considering utilization for establishing market rent to avoid adverse impacts of future negotiations.

Estimating Market Value and Establishing Market Rent 35 Under an RFP process, which is utilized to receive proposals for developing land, occupying improvements, and conducting aeronautical or non-aeronautical activities at an airport, proposers are typically required to include a financial aspect. The financial aspect of the proposal typically outlines a proposed rental rate for the subject land and/or improvements and may include a minimum annual guarantee. Selecting a proposer and executing an agreement at the proposed rental rate, in effect creates a market rent—a willing buyer (proposer) and a willing seller (air- port sponsor). It is important to recognize that, while rent for aeronautical land and/or improvements is often on a fixed basis (determined through a comparable rent analysis or appraisal with appro- priate adjustment mechanisms), a percentage of rent (utilizing gross sales or another metric basis) may be appropriate in certain instances. Additionally, rent for non-aeronautical properties (concessions, convenience store, etc.) may include a percentage rent basis. As it pertains to aeronautical land and/or improvements, a percentage rent (e.g., percentage of gross receipts) has become less common for general aviation purposes. It is also important to note that when a percentage rent basis has been applied, this should reduce the fixed rent for the land and improvements. Appraisal An appraisal is defined as the valuation of land and/or improvements by a qualified person, consistent with the requirements of the USPAP. As outlined in the definition, a person qualified to conduct an appraisal possesses the education, training, experience, and professional qualifica- tions (as determined by the airport sponsor) necessary to render a properly informed opinion regarding the value of land and/or improvements. An appraiser may also pursue becoming a member of the Appraisal Institute, which results in the designation of MAI. From a procurement perspective, certain municipalities may require appraisers to have an MAI designation when conducting an appraisal. Appraiser Qualifications For an appraisal of airport land and/or improvements for aero nautical or non-aeronautical use, it is most prudent for an airport sponsor, airport management, or airport property man- ager to ensure the appraiser understands the unique challenges of valuing land and improve- ments on an airport, and more importantly, a federally obligated airport. This is important because airport land and/or improvements do not have the same “bundle of rights” as off- airport properties. Before selecting an appraiser (or consultants), the airport sponsor, airport management, or airport property manager should consider the importance of requiring that the selected individuals have the requisite knowledge applicable to airport land and/or improvements. Depending on the underlying use of the land and/or improvements (aeronautical or non- aeronautical), it may be appropriate to ensure the selected individual possesses a working knowledge of the aviation industry and airports. Topics could include commercial operators (e.g., FBOs and SASOs) and non-commercial entities (e.g., aircraft owners and operators) and their related activities, as well as familiarity with federal and state legal requirements and FAA guidance (Assurances, orders, polices, advisory circulars, and other guidance materials) pertain- ing to airport land and/or improvements. It may also be appropriate, or even preferable given the specific situation or complexity of the airport, to ensure selection of the individuals with experience providing the same services at comparable airports. In most states, an individual or entity (other than the owner or employee of the owner) performing appraisals or broker’s opinion of value analyses must be licensed in the state where the property is located.

36 Estimating Market Value and Establishing Market Rent at Small Airports Valuation Approaches The appraisal process, consistent with the Dictionary of Real Estate Appraisal, includes three approaches to value—cost, sales comparison, and income. Central to each approach is the principle of substitution, as an astute real estate investor will pay no more than the value of an equally desirable alternative property or investment. Upon completion of each appropriate approach, a final estimate of value is determined by considering the quality and quantity of data available under each approach and the inherent advantages and disadvantages of each approach. Each approach to value is further described in Figure 4-3. A survey conducted for this research showed that 56% of the survey participants identi- fied the income approach as the preferred approach for airport land and/or improvements (Figure 4-4). •Considers the current cost of replacing the building and improvements on a property, less depreciation, plus the market value of the (leasehold) land assumed vacant. • •This approach is effective in valuing relatively new (or even proposed) developments or special-purpose properties. Cost Approach •Involves direct comparisons of similar properties, which have sold in the same or similar markets. •Data from comparable properties is analyzed and adjustments are made for significant differences. The adjusted sales are then weighted to provide an indication of value. •This approach is not a good indicator of value for properties being used for commercial purposes (e.g., FBOs and SASOs), as it is difficult to separate the value of the business enterprise from the value of the real estate. Sales Comparison Approach •Based on an estimate of the property's possible net income and measures the present worth of anticipated future benefits derived from property ownership. •Net income is capitalized to arrive at an indication of value, which converts the investment into present value. •Provision for the investor's recapture of invested capital, as well as for return on capital, is built into this procedure. Income Approach Depreciation affecting the property can occur from three sources: physical deterioration, functional obsolescence, and economic obsolescence. Figure 4-3. Appraisal approaches. 56% 33% 11% Income approach Sales comparison approach Cost approach Figure 4-4. Preferred appraisal approach.

Estimating Market Value and Establishing Market Rent 37 Uniform Standards of Professional Appraisal Practice Requirements As outlined in the USPAP, appraisals must meet certain requirements. While it is beyond the intended purpose of this report to identify and examine each of these requirements, certain aspects warrant discussion: • Market Analysis/Market Conditions—The market analysis/market conditions section must contain data and analysis consistent with the complexity of the appraisal assignment, with the focus on current market trends that affect the value and exposure time of the subject property. • Zoning Descriptions—The zoning description must address the subject property’s conformity or non-conformity with current zoning and must include an analysis of land use issues that affect (positively or negatively) the subject property’s legally permissible uses. Examples include pending zoning change, pending amendments to the general plan, open space overlay, pend- ing changes in local agency sphere-of-influence boundaries, scenic/view corridor restrictions, and restrictions under 14 CFR Part 77, Safe, Efficient Use, and Preservation of the Navigable Airspace (e.g., height limitations, setbacks, clear zones). • Description of Improvements—The description of the improvements, including their physical characteristics as well as their quality and condition, allows correlation of the property characteristics that have the greatest impact on market value or market rent. • Remaining Economic Life—If using the cost approach in the valuation analysis, the descrip- tion of the existing improvements must include a statement as to the estimated effective age and remaining economic life of the subject improvements. • Highest and Best Use—As previously discussed, appraisals must include an analysis of the highest and best use of the land as if vacant and the highest and best use as proposed. • Capitalization Rates—Overall capitalization rates and discount rates must be supported by data and analysis to reflect the current situation. The analysis should include a thorough understanding of the remaining term of the lease agreement, capital investment requirements, current vacancy rates, and other lease terms and conditions (e.g., reversion policy, lease assignment flexibility). Process—Market Value Upon initiating an appraisal process for aeronautical or non-aeronautical use, the appraiser must determine whether approaches to market value (cost, sales comparison, or income) are appropriate for the current process. If a certain approach is not used, the appraiser should explain the underlying reason. However, certain approaches are more or less appropriate for typical airport land and/or improvements situations: • Cost Approach – Most effective for analyzing new (or even proposed) improvements – Not effective for analyzing aeronautical or non-aeronautical land • Sales Comparison Approach – Effective for analyzing non-aeronautical land and non-commercial improvement transactions (e.g., hangar transactions) – Not effective for analyzing aeronautical land and improvements utilized for commercial purposes • Income Approach – Effective for analyzing improvements utilized for commercial and non-commercial purposes – Effective for analyzing aeronautical leasehold land and non-aeronautical leasehold land For proposed improvements, the cost approach should be utilized to test their financial feasibility. When cost exceeds value or when the indication of project profitability is below typical expectations for similar improvements, an expanded highest and best use analysis is required.

38 Estimating Market Value and Establishing Market Rent at Small Airports Upon selection of the appropriate approaches, supporting data will determine the ultimate value conclusion. The cost approach can be substantiated by utilization of a widely recognized and highly regarded national publication (e.g., Marshall Valuation Service) as the basis for determining the economic life and appropriate depreciation as well as the cost of construction. National, regional, or local transaction data (or listings) will substantiate the sales comparison approach. As stated in Compliance Guidance Letter 2018-3, Appraisal Standards for the Sale and Disposal of Federally Obligated Airport Property, the FAA highly recommends that when estimating market value or establishing market rent, an “aeronautical property is compared to other aeronautical property serving the same function at similar airports.” As it pertains to the income approach, utilization of the process outlined in Comparable Rent Analysis (in this section) is most appropriate. However, the airport and property characteristics outlined in Chapter 5 of this report will directly impact the comparable and competitive airports identified, as well as the airport property and land characteristics analyzed. The quantity and quality of data available for examination under each approach, as well as the inherent advantages and disadvantages of each approach, should be considered and weighed to derive a final opinion of value. Appraisal Process—Market Rent An appraisal process, by implementation of each appropriate approach, results in a conclu- sion of value—the price to “buy” an asset. However, because of procurement policies or lease agreement terms and conditions, an appraisal may be required in support of establishing market rent for aeronautical properties—the price to “lease” or rent an asset. Additionally, estimating the market value and utilizing a rate of return to establish market rent finds application for non-aeronautical, on-airport properties. In these instances, the appraiser (or consultant) must determine an appropriate rate of return that, in combination with the value conclusion, results in an opinion of market rent. General commercial real estate return on capital rates typically range from 6% to 12% (but may be as high as 15%). The disparity in applicable capitalization rates results directly from the special-purpose nature of aeronautical properties with limited supply. Conversely, non- aeronautical land uses have significant competition from off-airport locations, varying struc- tures (fee simple compared with leased fee), and restrictions on use of property on an airport (e.g., height restrictions). As it directly relates to airports, a survey conducted for this research indicated rate of return expectations ranging from 3% to 15%, with 10% being identified most often by survey participants. When determining an appropriate rate of return for an airport, considerations include • Size, complexity, classification, and activity of the airport; • Property use (aeronautical, non-aeronautical, commercial, non-commercial); and • Current demand in the local and national marketplace. Comparable Rent Analysis A comparable rent analysis can serve as a key component of an appraisal (to estimate market value or establish market rent using the income approach) or as the underlying basis of a rent study (to establish market rent for aeronautical purposes). Essentially, a rent study is a streamlined approach used to derive an opinion of market rent for airport properties without conducting an appraisal. The rent study (and comparable rent analysis) falls within the “objective determination” clause of the FAA Policy Regarding the Establishment of Airport Rates and Charges, which also indicates that market rent for airport properties being used for general

Estimating Market Value and Establishing Market Rent 39 aviation purposes can be established using any reasonable, justified, and consistently applied methodology. A comparable rent analysis compares rental rates for similar land and improvements at simi- larly situated airports (i.e., comparable and competitive) to derive a supported market-based rental rate for the subject land and/or improvement. Analyzing the survey conducted for this research indicated that participants believed utilization of existing rental rates for similar prop- erties at competitive/local airports was more appropriate than utilization of existing rental rates for similar properties at the subject airport or comparable airports. However, the type of airport land and/or improvement may impact the availability of existing rental rates for similar proper- ties at competitive/local airports. Qualified Persons For a comparable rent analysis, it is most prudent for an airport sponsor, airport management, or airport property manager to ensure the party selected to conduct the analysis (appraiser, consultant, or airport sponsor employee) understands the unique challenges of leasing land and improvements on airports. Before selecting a specific party to conduct a comparable rent analysis, it is imperative to ensure the party has the requisite qualifications to evaluate airport land and/or improvements and a working knowledge of the aviation industry and airports (including commercial operators and non-commercial entities and related activities). Also necessary are familiarity with federal and state legal requirements and FAA guidance (Assurances, orders, policies, advisory circulars, and other guidance materials) pertaining to airport land and/or improve- ments being used for aeronautical purposes. It may also be appropriate, or even preferable given the specific situation and/or complexity of the airport, to ensure selection of a party with experience providing the same services at comparable airports. Comparable Rent Analysis Process—Market Rent The objective of a comparable rent analysis is to establish an opinion of market rent for the subject airport land and/or improvements based on a comparative analysis of the rental rates being charged for similar land and/or improvements at comparable and competitive airports. Rental rates and related information obtained from similarly situated airports (i.e., comparable and competitive as outlined in Chapter 6) are analyzed to derive an appropriate, market-supported, rental rate for the subject airport land and/or improvements. Upon identification of comparable and competitive airports based on the characteristics identified in Chapter 5, the subject airport property characteristics (land or improvement) can be analyzed. In a component approach (as discussed in Section 4.2), the analysis can compare each component of the subject airport land and/or improve- ments with the same type of component at comparable and competitive airports. Additionally, to ensure consistency in establishing market rent, airport land and airport improvements can be categorized by use and attributes. Upon gathering the relevant and useable information from comparable and competitive airports, appropriate adjustments should be considered based on the subject airport property characteristics (as discussed in Chapter 5) to derive an opinion of market rent. While Order 5190.6B, the Airport Compliance Manual, states, “ground leases with terms of five (5) or more years should contain an escalation provi- sion for periodic adjustments based on a recognized economic index,” it is also important to consider these impacts on a long-term agreement (e.g., 30 years). For example, the situation at many of the busiest general aviation airports during the 1990s is not reflective of the current situation at those same airports. The market has changed significantly for any number of reasons. For example, the Denver metropolitan statistical area in 1990 was estimated by the U.S. Census Bureau at approximately 1.6 million per- sons, while the most recent estimation is approximately 2.8 million persons. This increased demand may result in market value and market rent at the airport accelerating at a faster rate than the consumer price index. For these purposes, it is appropriate to have a market-based adjustment throughout a long-term agreement.

40 Estimating Market Value and Establishing Market Rent at Small Airports 4.4 Adjusting Market Rent Consistent with the Assurances and other FAA guidance, airport sponsors, airport manage- ment, and airport property managers should determine a fair, reasonable, and consistently applied approach for adjusting rental rates for aeronautical land and improvements at the air- port. This approach should outline the frequency, methodology, and any pertinent parameters. Order 5190.6B, the Airport Compliance Manual, states that “ground leases with terms of five (5) or more years should contain an escalation provision for periodic adjustments based on a recognized economic index” as a means of facilitating parity between new lease agreements and existing lease agreements. However, based on the results of the survey conducted in this research, a periodic adjust- ment using a recognized economic index only for lease agreements with terms of 5 or more years does not appear to be consistent with the realities of the aviation industry. Approxi- mately half of the survey respondents (which consisted of airport property developers, airport property real estate agents, airport property lessees, and airport management representatives) indicated that it is appropriate to adjust the underlying rental rate on an annual basis. Adjust- ing rental rates on a consistent, regular, and frequent basis ensures the rental rates are gener- ally reflective of market conditions and pace inflation. At the same time, regular adjustments prevent the potential for “sticker shock” that longer intervals can cause. Further, regular adjustments provide the airport sponsor a reasonable return on the land—which is more consistent with Assurance 24 that requires an airport to be as financially self-sustaining as possible given its circumstances. Upon identifying the frequency of rent adjustment (e.g., annual, every 5 years), the method- ology must be determined. Consistent with industry standards and the survey responses, the Consumer Price Index (CPI) was identified as the most common economic index for adjust- ment to airport property rental rates. However, some airport sponsors have elected to utilize a fixed percentage adjustment mechanism (e.g., 2%, 3%). The fixed percentage adjustment can be based on historical CPI fluctuations but provides certainty to both the airport sponsor and the lessee as to the index adjustments throughout the term. Survey respondents also indicated that a market adjustment (e.g., appraisal or comparable rent analysis) is appropriate and should be considered every 5 to 10 years of a lease term. It may be appropriate for an airport sponsor, airport management, and airport property managers to consider parameters pertaining to rental rate adjustments. For example, it is consistent with general real estate practices as well as with industry best practices to set a minimum adjustment of 0%—effectively stating rental rates will never decrease. Further, airport sponsors may consider a maximum adjustment (e.g., 3%, 5%) to provide existing and potential lessees certainty throughout the term. 4.5 Amortization When entering into a lease agreement for new improvements to be constructed by the lessee, the term of the lease is vitally important. This aspect of the lease agreement is so important that developers and real estate agents cautioned that a lack of adequate term, which would provide time to fully amortize an investment, could effectively eliminate interest in negotiating with the airport sponsor. While survey respondents indicated that a lease term of 20 to 40 years, depending on the type and level of investment, was necessary to amortize a significant capital investment, some airport sponsors may not be agreeable to a term of this magnitude. However, Order 5190.6B, the Airport Compliance Manual, states, “Most tenant ground leases of 30 to 35 years are sufficient to retire a tenant’s initial financing and provide a reasonable return for the tenant’s development of major facilities.”

Estimating Market Value and Establishing Market Rent 41 Additionally, an airport’s minimum standards or leasing policy may dictate certain capital investment levels for each type of lessee to attain a certain length of term (e.g., 30 years). An existing or prospective lessee may not propose capital investment to attain a long-term agree- ment but may desire to amortize the capital investment over a longer term. It is in these situa- tions, with consideration given to the demand at the airport and financial position of the airport sponsor, that an agreement with an amortization schedule beyond the term of the agreement may be appropriate. Under this type of agreement, the airport sponsor would have the sole option at the end of the term to • Compensate the lessee for the unamortized portion of the capital investment; • Enter into a new lease agreement with the existing lessee providing for continued amortiza- tion of the capital investment commensurate with the remaining amortization period; or • Enter into a new lease agreement with a new lessee and require the new lessee to compensate the existing lessee for the unamortized portion of the capital investment. 4.6 Chapter Review Utilizing the background and FAA guidance as a basis, along with the results of the survey conducted for this research, Chapter 4 provided the framework for estimating market value and establishing and adjusting market rent. Before these processes (as applicable) are initiated, the decision framework is instrumental to the approach, as outlined in Figure 4-5. Consider highest and best use •Consider the “reasonable, probable, and legal use of vacant land [or improvement] which is physically possible, appropriately supported, financially feasible, maximally productive, and results in the highest value,” which will determine the type of analysis conducted. Determine appropriateness of utilizing off-airport properties •Before initiating the process, determine if off-airport properties are appropriate for the analysis. This determination will be intrinsically linked to the property subject to the analysis (aeronautical or non-aeronautical). Outline approach (component or blended) •Outline the underlying approach of analyzing the subject airport land and/or improvements on a blended approach (analyzing the entire leased premises as one unit) or analyzing each individual component of the subject property to determine an overall conclusion. Figure 4-5. Chapter 4 key aspects.