TO: HONORABLE MAYOR
AND CITY COUNCIL
FROM: Mukesh (Mookie) Patel
SUBJECT: See Below DATE: January 6, 2025
Approved
Date:
1/8/25
COUNCIL DISTRICT: Citywide
SUBJECT: Amendment to the Lease and Specialized Aviation Service Operating Agreement with SJC Hangars LLC
RECOMMENDATION
Approve the first amendment to the lease and specialized aviation service operations agreement between the City of San José and SJC Hangars LLC (dba Sky Harbour) to include provisions to address potential construction delays if the required approvals and associated environmental review to build additional hangar space are not received within the first two years of the executed agreement.
SUMMARY AND OUTCOME
On March 21, 2024, the City entered into an airport hangar lease and specialized aviation service operations agreement (hereinafter lease of premises or agreement) with Sky Harbour. Sky Harbour developed a creative solution to meet the San José Mineta International Airport’s (Airport) ambitious lease revenue target by constructing approximately 28,000 square feet of additional hangar space on the property with a capital investment of $8,116,392. This approach enabled Sky Harbour to expand its revenue-producing facilities, while the Airport met its minimum lease revenue goal.
However, executing this plan requires Sky Harbour to assume higher risk than is typical for its business model.
The future hangar expansion is contingent upon Sky Harbour obtaining required federal and state approvals necessary for the new hangar project to move forward. As part of the original negotiations with Sky Harbour, the City and Sky Harbour agreed to the good faith language as included in Section 2.3 of the agreement, due to the fact that Sky Harbour took on a higher level of investment and risk than is typical for its business model. The intent of this amendment is to allow for a rent reduction should the process for the approvals take more than two years to receive as further described in this same COUNCIL AGENDA: 1/28/25
FILE: 25-045
ITEM: 2.7
HONORABLE MAYOR AND CITY COUNCIL
January 6, 2025
Subject: Amendment to the Lease and Specialized Aviation Service Operating Agreement with SJC Hangars LLC
section of the agreement. In the unlikely event that the required approvals are not received or are denied by April 30, 2028, the City is offering Sky Harbour a reduced term option to 10 years with a rent reduction to be solely exercised by Sky Harbour.
The desired outcome of the amendment is to allow for the City and Sky Harbour to continue to pursue construction of the hangar expansion. If Sky Harbour is unable to receive the required National Environmental Policy Act and California Environmental Quality Act approvals, the amendment allows for Sky Harbour to revert to an agreement that still meets the minimum bid requirements of the request for proposal (RFP) issued by the City.
BACKGROUND
On September 20, 2023, the City issued an RFP for the lease of the premises for General Aviation Aeronautical Services at 1210 Aviation Avenue, in San José. The minimum terms of the RFP included the option for a 10-year term with minimum annual rent of $2,200,000 or a 20-year term with minimum annual rent of $2,800,000. The lease of space consists of 7.08 acres comprised of approximately 283,188 square feet of hangar and office space, associated ramp for aircraft operations, and 112 automobile parking spaces. The facility was originally built and occupied by Hewlett Packard Enterprise, and on January 26, 2023, the City negotiated a settlement to terminate the lease with Hewlett Packard Enterprise and buy out the remaining term for $2,200,000.
At the time, staff estimated the annual fair market lease value of the property to be $1,700,000.
On December 12, 2023, City Council approved the award of the agreement to Sky Harbour Group Corporation, the owner of SJC Hangars LLC, for a lease term of 20- years with one five-year option to extend with a minimum lease payment of $2,865,000 per annum, subject to annual increases based upon the Consumer Price Index (CPI).
The agreement was executed on March 21, 2024, and Sky Harbour took possession of the facility on April 1, 2024. Sky Harbour plans to construct an additional 28,000 square feet of hangar space on the premises. Upon completion of the hangar, Sky Harbour’s rent will increase to $3,122,661. Before construction can begin, both National Environmental Policy Act and California Environmental Quality Act approvals are required.
While City staff has started the process to seek required approvals, the approval process can be lengthy and is expected to take up to two years. City staff fully expects each of these impact reports to be approved within the two-year timeframe and if the approvals are received, there would be no adjustment to the terms of the agreement.
However, if such reports are not approved, or should the approval process take longer than the expected two-year time frame, the agreement would be amended with the following terms below.
HONORABLE MAYOR AND CITY COUNCIL
January 6, 2025
Subject: Amendment to the Lease and Specialized Aviation Service Operating Agreement with SJC Hangars LLC
• If approvals are not received by April 30, 2026, Sky Harbour would receive a rent reduction for the period of May 1, 2026 through April 30, 2028, or until approvals are received, whichever comes first.
• If required approvals are not received by April 30, 2028, Sky Harbour would have the option to reduce the total term of the lease to 10 years. If Sky Harbour exercises the option to reduce the term of the lease, the rent amount beginning on May 1, 2028, would be calculated as $2,200,000 plus the cumulative percentage of the CPI from all previous years. • If approvals are received by April 30, 2026, there would be no rent reduction and the option to reduce the length of the lease would not be available.
The City’s rent reduction adheres to the minimum requirements of the RFP, which offered proposers two options listed below.
• 10-year term with minimum annual rent of $2,200,000; or • 20-year term with minimum annual rent of $2,800,000.
To ensure the average rent met the RFP minimums over the entire agreement, staff offered a discount for years three and four. This discount is applied to the base rent amount of $2,865,000 after CPI is applied at the end of year one and two and reduces the rent to no less than $1,919,550 for those years. To balance the discount, the first two years of the agreement have a higher minimum payment of $2,865,000. This ensures a combined total of no less than $9,569,000 over four years, which is an annual average of $2,392,250, exceeding the minimum RFP requirement of $2,200,000.
In the unlikely event that the National Environmental Policy Act and California Environmental Quality Act approvals are denied or said approvals are not received by April 30, 2028, and Sky Harbour exercises its right to reduce the term of the agreement to ten years, the rent beginning on the fourth anniversary would be adjusted to $2,200,000 plus the cumulative percentage of the CPI for years one through four. On each subsequent anniversary, the rent would be subject to increase based on CPI in accordance with the terms of the agreement.
ANALYSIS
Sky Harbour and the City negotiated a lease that placed a certain amount of business risk on Sky Harbour. For that reason, the City negotiated terms in good faith to align with the long-term goals of attracting high-quality development that will benefit the City’s economy and the Airport, while maintaining a positive business relationship with our tenant. City staff, therefore, recommends approval of the proposed amendment to the agreement with Sky Harbour.
The proposed amendment guarantees a minimum of $9,569,000 in revenue for the first four years, averaging $2,392,250 annually. This exceeds both the City’s estimated fair market value of $1,700,000 and the RFP minimum bid of $2,200,000.
HONORABLE MAYOR AND CITY COUNCIL
January 6, 2025
Subject: Amendment to the Lease and Specialized Aviation Service Operating Agreement with SJC Hangars LLC
Approval of the amendment remains financially favorable for the City. In the unlikely event that the environmental approvals are not received and should Sky Harbour decide to exercise the option to reduce the term to 10 years, the overall value of the agreement would still result in over $27 million in revenue to the City. Sky Harbour and the City retain the one-time option to extend the term by five years, and if exercised, the total value of the potential 15-year agreement would be in excess of $40 million to the City.
EVALUATION AND FOLLOW-UP
The Director of Aviation shall render overall supervision of progress and performance.
COST SUMMARY/IMPLICATIONS
All maintenance and repairs and current and future improvements will be the sole responsibility of Sky Harbour, except for the hangar’s base building structure and roof, which shall be maintained by the Airport Department. The Airport’s responsibilities will be funded in the Airport Renewal and Replacement Fund.
COORDINATION
This memorandum has been coordinated with the City Attorney’s Office and the City Manager’s Budget Office.
PUBLIC OUTREACH
This memorandum will be posted on the City’s Council Agenda website for the January 28, 2025 City Council meeting.
COMMISSION RECOMMENDATION AND INPUT
This is an administrative function; therefore, no commission recommendation or input is associated with this action.
CEQA
Not a Project, File No. PP17-003, Agreements/Contracts (New or Amended) resulting in no physical changes to the environment.
HONORABLE MAYOR AND CITY COUNCIL
January 6, 2025
Subject: Amendment to the Lease and Specialized Aviation Service Operating Agreement with SJC Hangars LLC
PUBLIC SUBSIDY REPORTING
This item does not include a public subsidy as defined in section 53083 or 53083.1 of the California Government Code or the City’s Open Government Resolution.
/s/
Mukesh (Mookie) Patel, C.M.
Director of Aviation
For questions, please contact Matthew Kazmierczak, Division Manager, Airport Department at (408) 392-3640.