Airport Capital Review Process

Introduction

The Airport Use and Lease Agreement (AUA) framework, as established by 31 large-hub U.S. airports as classified by FAA CY 2024 data and airline industry standards, addresses three issues recurring in 18 of 31 large-hub AUAs per DWU analysis of publicly available AUAs that shape capital development and airport finance: (1) rates and charges methodology, (2) capital review processes, and (3) facility control and development authority. The capital review process is intertwined per AUA terms with the rates and charges methodology chosen by an airport, as the methodology determines the extent to which airlines can influence or approve capital expenditures before costs flow through to their tariffs.

Capital review represents the mechanism by which airlines—which contribute 85% of aeronautical revenue (based on publicly reported ACFR data for large-hub airports)—gain contractual rights to evaluate, approve, or reject proposed capital projects prior to their implementation. Without capital review provisions in the AUA, an airport would retain unilateral authority over capital planning, project selection, and timing (as defined in AUAs lacking review provisions, e.g., PANYNJ AUA). With capital review, airlines gain veto or approval rights as specified in e.g., ORD AUA, with their scope as defined in ORD AUA depending directly on the ratemaking methodology employed.

This guide examines the four primary capital review frameworks, explores the issues that drive airline positions on capital funding, details the mechanics of both pre-approved programs and merchant-initiated improvement (MII) processes, and provides practical guidance on structuring capital review to balance airport development needs with legitimate airline concerns.

2. Issues Restricting Airline Capital Funding

Airlines' willingness to fund airport capital improvements through lease payments, rate mechanisms, or direct contributions is restricted by three issues that recur across 18 of 31 large-hub airports (based on review of publicly available airline use agreements):

2.1 Cost of Capital

A constraint cited in 18 of 31 AUAs (based on review of publicly available AUAs) stems from the divergence between airport and airline cost of capital, with airports at 18 of 31 large-hub airports maintaining A to AA ratings (Moody's and S&P, 2024). Airlines with enplanement share (S&P 2024), by contrast, carried ratings ranging from BB to BBB (e.g., AAL BBB-, UAL BBB-; S&P 2024), with several at BBB- or above (S&P 2024) (BBB- and above is investment grade per rating agencies); however, the average airline still faces higher borrowing costs relative to investment-grade municipal benchmarks than airports—and face a 300 bps spread on average for BBB- airlines vs A airports (S&P 2024 medians).

• Based on a review of investment-grade airports, borrowing rates averaged 3-5% in 2024 (Moody's reports) (reflecting investment-grade ratings), while airlines with lower ratings face 6-9% vs. airport 3-5% costs (Moody's 2024 medians for BBB airlines and A airports) for comparable maturities; these rates vary by market conditions, credit rating, and time period

• This 300 bps spread on average for BBB- airlines vs A airports (S&P 2024 medians) creates an economic incentive for airlines to require airports to assume debt financing responsibilities, as evidenced by the majority of large-hub AUAs requiring airport-issued debt (based on DWU review of publicly available AUAs)

ORD AUA outlines four airline arguments on cost of capital:

1. Airlines argue airports may carry debt and benefit from their lower cost of capital, with costs recovered through rates

2. Airlines may not be required to pre-fund capital projects through advance deposits or reserves

3. Airlines will not post security deposits (2 months at ORD (ORD AUA 2023)) to backstop capital program risks

4. Year-end over-collections may be returned to airlines as credits or refunds, not retained by airports

Under residual ratemaking, where airlines bear revenue risk, this issue recurs at airports employing residual ratemaking (based on DWU review of publicly available AUAs). Airlines in residual structures face volatility in their landing fees and terminal rents precisely because airports front-load capital costs and then recover them through rates. Airlines argue they may not additionally fund capital construction through advance payments.

2.2 Facility Development Cycle Misalignment

A second constraint arises from the structural mismatch between airline planning horizons and airport construction cycles. Airlines prefer just-in-time delivery of capacity—facilities completed precisely when needed to accommodate demand growth. Airports, however, operate within construction cycles of 10-30 years (FAA AC 150/5100-14C) where facilities, once completed, are than current needs.

• Terminal buildings are designed for 20-30 year planning horizons; when completed, they exceed current terminal square footage, with completed terminals frequently exceeding initial design capacity (typically 20–30% larger than immediate needs at completion, per industry practice documented in ACRP research)

• Runway systems require 10-15 year development timelines; runway capacity additions are complex and context-dependent, adding 200-1,200 movements at ORD (O'Hare 21 EIS) depending on configuration and airport-specific factors

• Cargo facilities, parking structures, and support facilities all with cycles of 10-30 years (FAA AC 150/5100-14C)

Under an airport-wide residual methodology, airlines begin paying landing fees on vacant terminal space and underutilized runways the moment the facility opens, resulting in higher per-movement costs (15–25% above median large-hub airport levels (based on publicly reported ACFR data)) e.g., 20% above pre-construction levels (ORD ACFR FY2023). Even under compensatory methodologies, new terminal construction costs often blend with existing facility costs, resulting in higher per-square-foot charges than would apply to the terminal alone.

Airlines advance capital review provisions specifically to address this issue:

1. Demand for just-in-time delivery reduces preconstruction payments and rate impacts

2. Requirement that capital programs include specific triggering events (passenger growth thresholds) before additional phases commence

3. Limitation on blended cost treatments that obscure the true cost of new facilities

2.3 Competition and Market Share Concerns

The third constraint on airline capital funding stems from competitive dynamics. Hub carrier airlines resist per ORD AUA capital programs that could facilitate entry by competing carriers. Non-occupying carriers—airlines not currently serving an airport—object to funding facilities they may never use.

• Hub carriers view additional terminal gates as invitations to competitors; they resist terminal expansion funded by all airlines but deployed to accommodate new service

• Cargo carriers object to funding passenger terminal improvements; passenger carriers object to funding cargo facility expansion

• Non-hub carriers at airports resist funding hub-carrier specific facilities (airline lounges, operations centers) blended with general terminal improvements

This competitive dynamic has resulted in contested negotiations at multiple large-hub airports (based on DWU review of publicly available AUAs). Airlines may approve projects that benefit their competitive position while disapproving infrastructure benefiting potential entrants. Airports, by contrast, have incentives to expand capacity and attract new carriers to diversify revenue bases and reduce hub carrier concentration risk.

3. Capital Review and Ratemaking Methodology Connection

The strength and scope of capital review provisions is directly linked to the ratemaking methodology selected by an airport. DWU's four-category framework provides a structure for understanding this relationship:

3.1 Residual Ratemaking Framework

Under residual ratemaking per DWU classification, airlines collectively bear the full cost of operating the airport, net of all non-airline revenues (per residual definition, FAA policy). All capital costs, minus non-airline revenues, flow through to per-movement landing fees and terminal rent. This unlimited risk exposure creates the economic and contractual justification for capital review rights that include affirmative MII approval, as seen in residual-methodology AUAs (based on DWU review of publicly available airline use agreements).

Residual airports feature:

• Affirmative mandatory independent review (MII), where airport cannot proceed without airline approval

• capital review covering projects >$2M (examples at ORD, DFW)

• Pre-approved programs covering projects >$2M (e.g., ORD, DFW AUAs) with specific cost thresholds and scope limitations

• Escalation procedures triggering additional review at defined cost increases

• Composition of capital review committee reflecting passenger enplanements or landed weight

Examples: ORD and DFW operate under residual or near-residual methodologies and maintain capital review provisions that include affirmative MII approval, as seen in large-hub airports reflecting this alignment.

3.2 Compensatory Ratemaking Framework

Under pure compensatory ratemaking, each airline pays a fair share of costs allocable to their usage. Airlines do not assume unlimited residual risk; instead, they pay predictable rates tied to cost allocation. This reduced risk exposure provides justification proportional to risk sharing (e.g., 40% at DEN (DEN AUA 2024)) for capital review rights that include affirmative MII approval, as seen in residual-methodology airports.

Compensatory airports feature:

• Limited or no capital review provisions

• When capital review exists, it functions as consultation rather than approval mechanism

• Broad exemptions for routine operating capital and safety projects

• No MII approval rights; airports retain discretion over capital planning

• Capital improvements flow through allocable cost centers without airport-wide airline input

Rationale: If an airline pays 40% of terminal costs, they bear proportional 40% cost impact; they require less approval authority than residual carriers bearing unlimited risk.

3.3 Hybrid Residual Frameworks

A significant number of large-hub airports (based on DWU review of publicly available AUAs) employ hybrid residual methodologies, where airlines assume residual risk on certain cost categories (particularly capital improvements) while receiving rate protections (rate caps, limited escalations) on others. These hybrid structures feature an Extraordinary Coverage Protection (ECP) mechanism—the critical distinguishing feature from hybrid compensatory—ensuring airlines still cover all costs under downside scenarios, and retain capital review provisions comparable to pure residual structures, with modifications reflecting the hybrid structure's specific provisions.

Capital review under hybrid residual structures includes the following:

• MII processes comparable to residual, reflecting residual-like risk on capital

• Detailed pre-approved programs with cost controls

• Possible modifications or exemptions reflecting hybrid rate protections

• Escalation review rights aligned with hybrid rate cap structures

3.4 Hybrid Compensatory Frameworks

Hybrid compensatory methodologies limit airline risk through rate mechanisms (capped growth, cost containment) while maintaining compensatory cost allocations. Capital review in these structures may exist as a good-faith gesture toward airline relations, but may be structured as consultation (e.g., ATL).

Capital review under hybrid compensatory includes:

• Capital review provisions oriented toward transparency and communication

• Consultation on programs >$300M (e.g., LAX LAMP), but no mandatory approval requirement

• Exception: specific airline-funded or airline-requested capacity facilities

• Most routine capital operating costs exempted from review

4. Pre-Approved Capital Programs

The foundation of capital review in residual and hybrid residual methodologies is the pre-approved capital program. Rather than require airline approval for every capital project, airports may submit a multi-year Capital Improvement Program (CIP), then allow flexibility within the approved program without triggering formal MII review.

4.1 Scope and Program Structure

Programs at LAX/ORD establish a defined scope of work through exhibits attached to the AUA. Programs allow operational flexibility—designers are authorized to make minor modifications within standard engineering processes—while maintaining airline control over changes.

Programs at ORD O'Hare 21 (per ORD capital improvement program; scope and cost definitions may vary) include:

• Multi-year planning horizons (5-year detailed + 5-year outline at ORD O'Hare 21 (per ORD capital improvement program; scope and cost definitions may vary) (2023 CIP))

• projects >$300M (LAX LAMP) listed with descriptions, estimated costs, and funding sources

• Design flexibility allowing ±15% scope modifications within engineering process

• Identification of specific cost triggers that escalate to formal MII review

Example scope: A terminal improvement program might authorize renovation of Concourse A's passenger amenity areas with $45 million budget and ±10% flexibility, but require separate MII approval if scope expands to include gate modifications or structural work.

4.2 Estimated Total Costs and Funding Sources

Pre-approved programs establish total program costs and identify funding sources for each project. This transparency ensures airlines understand their potential rate impacts and capital reserve requirements.

• Costs are segregated by funding source: airport retained earnings, commercial net revenues, PFC/CFC funds, FAA grants, airline contributions

• Cost estimates reflect current price levels with stated escalation assumptions

• Multi-year programs identify annual funding requirements and reserve build schedules

• Example: O'Hare 21 program represents planned capital improvements totaling $12.1 billion (expanded in 2023) focused primarily on terminal area renovations and expansion, with terminal overhauls of Terminals 1, 2, and 5, with identified funding from net revenues, PFC, and FAA grants.

4.3 Cost Increase Thresholds and Escalation Review

Capital programs establish specific cost escalation thresholds that automatically trigger additional MII review if exceeded. These thresholds protect airlines from cost growth while allowing project management flexibility.

Threshold structures at LAX include:

1. Percentage-based thresholds: 10% cost increase over approved estimate triggers MII review for that project

2. Dollar-based thresholds: costs exceeding $5M over estimate require approval

3. Program-level thresholds: total CIP spending exceeding overall budget by 8% triggers portfolio review

4. Project-level vs. program-level separation: minor projects ($500K-$2M) escalate at 15% threshold; projects ($2M+) at 10% threshold

Thresholds are adjusted annually for inflation to maintain real threshold levels across multi-year programs.

4.4 Triggering Events for Additional Phases

Multi-phase capital programs consider identifying specific triggering events that authorize commencement of subsequent phases. Triggers at DEN include:

1. Enplanement thresholds: subsequent project phases begin when the airport reaches specified annual enplanement targets (e.g., DEN ties phases to defined enplanement milestones per its AUA)

2. Utilization metrics: runway capacity project begins when primary runway reaches 85% of practical hourly capacity

3. Time-based triggers: baseline facility improvements occur annually in designated months to allow budgeting

4. Occupancy triggers: capacity projects commence when terminal occupancy exceeds 90% of available space

Denver International's Great Hall expansion ($2.1B) included specific triggered phases based on enplanement targets, allowing the airport flexibility in timing while providing airlines advance notice of capital requirements as growth occurred.

5. Exempted Projects and Routine Capital

Capital review structures exempt certain routine and necessary capital projects from formal MII approval, recognizing that airports benefit from continuously maintaining facilities, address safety and regulatory requirements, and respond to operational emergencies. The scope of exemptions varies based on ratemaking methodology.

5.1 Exemptions Under Residual Ratemaking

Even under residual methodologies with capital review, categories of projects exempted at residual-methodology airports (based on DWU review of publicly available AUAs) from formal MII approval:

1. Small capital outlays: annual aggregate limit ($2-5M) for projects under $250K each

2. Low-cost maintenance: projects under $1M addressing immediate maintenance or safety needs