Cash Flows and Equipment Values
The sources of lease cash flows change in importance over time. Each are subject to different risks. Accounting, tax, credit, and equipment risk vary throughout and affect transaction economics. Cash flows are further dependent on the macro environment, specific equipment involved, and the type, tenor, and terms and conditions of the lease agreement you choose to write. Control these risks and you’ll have the opportunity to increase your returns.
To be comfortable with equipment, experience teaches a lessor needs to be in both primary (new equipment) manufacturing markets and the secondary equipment market on a consistent basis. Only current knowledge of equipment availability, pricing, part out and reconfiguation opportunities creates the ability to appreciate the relative ‘liquidity’ of secondary equipment opportunities at any point in time. Aircraft in production with current technology and a wide in-place user base compete with the lower capital cost of retaining or acquiring existing mid-life aircraft. But, as mid-life aircraft age “part out” values are compared to present values of proceeds from releasing or outright sale. And, equipment value and marketability is always relevant at lease end or in the event of a lessee default.
How do you best estimate the equipment value at risk? Three yardsticks: the value you choose to book as a residual, the actual fair market value at any point in time, and by reviewing value history and current trends. There are different approaches; a simple depreciation curve (with a volatility overlay), use of statistical database analysis (distribution of lowest and highest values experienced over time), tracking the relative value relationship between new and existing equipment pricing, and finally overlaying each of these with current supply and macro demand forecasts. Other factors include geography and physical usage (wear and tear), technology, and regulatory changes. What stage will the business cycle be in when equipment becomes available? An expanding economy supports stronger equipment values. Modal shifts such as truck to train, or single ailse to double aisle, and competitive dynamics within market segments also affect equipment values. What of inflation, polictics, and “black swan” events?
Solving this challenge? Current market information provides context, but it does not tell you a lot about the future. Investment modeling provides guidance; however, it is market experience that matters. Both Rail and Aircraft equipment have significant useful lives (25+ years). Both are subject to current market conditions when available for placement. Investing requires both current market information and long-term experience. Only experience teaches you the range of future possibilities.
What is your equipment worth? Think about the market value curve, the number of users of the equipment in question (liquidity), and your ability to recondition or modify equipment for alternate service. Is the equipment essential to the lessee’s business? Can it be easily replaced with existing lessee inventory or with availability in the secondary market? Without a specific transaction or timing of need, equipment can have a range of values. Low values represent risk. High values rewards. A lease is a bundle of cash flows supported principally by equipment value. And, it’s this estimate of equipment value that affects your transaction’s ‘value at risk’. In both the Air and Rail markets you need confidence to invest. Only experience brings that to the table.
Wondering about the future of equipment values? Talk to the transport specialists. Call RESIDCO.
 Risk distributions should take into account the possibility of ‘extreme’ events.
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