Global uncertainty, regulatory changes and fiscal contraction are compelling airports to look to their land assets for non-traditional revenue sources.
While there's no debate as to why airports must diversify their real estate portfolios by adding marketsupported commercial land development and associated revenues, the question remains: how can airports implement financially viable commercial projects as part of their operating strategies?
When public airports invest in commercial development, there's a clear nexus of public benefits, including regional economic development, buffers to neighbouring communities, enhanced passenger experience and convenience and airport revenue diversification, among others. However, given limited airport discretionary budgets, the ability to self-perform commercial development is all but non-existent. For this reason, airports are faced with making tough choices among a range of financing alternatives, with varying degrees of risk, reward and control.
When a new 28-gate midfield passenger terminal complex opened at Southwest Florida International Airport in Fort Myers, airport officials began planning and pursuing regulatory approvals for the redevelopment of hundreds of acres surrounding the former passenger terminal site. Now, airport administrators are deciding which financing alternatives are the most appropriate for implementing new commercial development, as part of their overall revenue diversification strategy.
In general, five financing alternatives are available to airports implementing new commercial developments: ground lease, special purpose authority, joint venture, airport-owned and third-party operated, and airport-owned and operated. Each alternative has advantages and disadvantages related to revenue stability, capital and credit risks, quality and schedule control, and return on investment. A ground lease represents the traditional development model at airports in that it is a simple lease of property to a developer. This alternative requires no airport capital and generates a lease payment (base rent) typically based on a percentage of appraised property value plus, depending on the use, a percentage of sales from the new business enterprise to be developed on site.
The ground lease alternative provides a stable revenue stream without the risk of airport capital. In turn, the airport has limited opportunity to participate in any upside (profitability) and less control of the customer experience. A ground lease works well when development opportunities are site specific, of a defined scope and scale, and the airport desires the least amount of risk.
Daytona Beach International Airport in Florida has successfully deployed ground leases as a financing alternative to implement new commercial development on site. Notable ground leases have included the iconic Daytona International
Speedway and world-renowned Embry-Riddle Aeronautical University main campus.
A special purpose authority can be created in which the airport oversees the actions of the authority. The authority, which has greater cost of capital than the airport, controls the development of the property and compensates the airport for the land that is developed. The authority keeps the rents generated by the businesses developed on site and uses such rents for reinvestment in the development.
When compared to the ground lease, the special purpose authority alternative provides the airport with more control of the development with limited or no airport capital at risk. The airport can also extract more upside but returns to the airport are limited due to the nature of the relationship.
Special purpose authorities are optimal when the amount of property available and the scale of associated market-supported development are sufficient to achieve economies of scale that fully leverage the new authority.
A joint venture (JV) involves the airport partnering with a developer to develop property jointly and split profits according to an upfront formal agreement.
The JV leverages the airport's cost of capital while bringing strong development expertise from the private sector, creating the possibility of more economic return to the airport.
At the same time, the JV places more airport capital at risk and creates the challenge of aligning developer and airport interests through potentially difficult legal structures. A JV works best when there are clearly defined, quality, financial and performance expectations for a specific project or development programme that can capitalise on those benefits associated with a public-private initiative.
The airport-owned and third-party operated alternative requires the airport to provide the capital for the development while contracting out the operation of the commercial enterprise to a third party. The airport retains all revenues associated with the development's operations. This alternative leverages the airport's cost of capital and provides the airport with more control over the final design and construction. While there are more variable costs for the airport, the airport receives all revenues but it must also assume all capital risk.
A potential challenge associated with the airport-owned and third-party operated alternative may exist in that the operator may not have comparable incentives to the airport and operator performance and corresponding airport
revenue may be constrained in this way.
This alternative can be a good choice for a project when the airport believes controlling ownership of the asset in the long-term protects its interest.
An airport-owned and operated financing alternative requires the airport to provide all capital for the development but the operation of the commercial enterprise is executed using airport resources and staff. The airport retains all of the revenues and this alternative leverages the airport's cost of capital while providing operating cost control.
Potential disadvantages of the airport-owned and operated alternative include financial exposure and associated credit risk related to the development's performance, which could lead to an increased cost of capital for the airport. If
the commercial enterprise is not part of the airport's core business, there is also a risk of directing too many airport resources to the endeavour.
This alternative may be appropriate if the airport is able to identify successful models that can be benchmarked in order to proactively identify and mitigate exposure to development and operational risks.
Successful implementation of new commercial development projects ultimately depends on an airport's ability to define and adopt a long-term commercial development strategy and plan.
This strategy must address the airport's tolerance for capital and operating risks, need for control, and specific revenue and return on investment goals. At the same time, a plan must remain flexible to respond to changing property values, real-time market context and sensitivities, supportable development, scale and timing issues.
An assessment of prevailing market conditions can inform airport officials as to when implementing elements of an overall commercial development plan is optimal and consistent with priorities and goals for specific development sites.
This assessment must consider not only the airport's risk tolerance at any given time, but also that of private developers and private equity. Only then can the plan serve as an effective decision support tool for selecting the appropriate financing alternative to achieve airport revenue goals and the community's broader vision.
How will you choose to capitalise on your airport's fertile ground?
About the author
Matthew S Taylor is the US national director of land use and market strategies for the C&S Companies (www.cscos.com). He can be reached at mtaylor@cscos.com.
