Rental Nation: Unique "Solution" Emerges To Address Flood Of Off-Lease Vehicles...Lease Them Again

We"ve written frequently of late about the coming wave of off-lease vehicles that threatens to flood the used car market with excess supply, crush used car prices and simultaneously wreak havoc on the new car market as well. 

As we recently noted (see: "Flood Of Off-Lease Vehicles" Set To Wreak Havoc On New Car Sales), the percentage of new car "sales" moving off dealer lots via leases has nearly tripled since late 2009 when they hit a low of just over 10%.  Over the past 6 years, new leases, as a percent of overall car sales, has soared courtesy of, among other things, low interest rates, stable/rising used car prices and a nation of rental-crazed citizens for whom monthly payment is the only metric used to evaluate a "good deal"...even though leasing a new vehicle is pretty much the worst "deal" you can possibly find for a rapidly depreciating brand new asset like a car...but we digress.

Of course, what goes up must eventually come down.  And all those leases signed on millions of brand new cars over the past several years are about to come off lease and flood the market with cheap, low-mileage used inventory.  By the end of 2019, an estimated 12 million low-mileage vehicles are coming off leases inked during a 2014-2016 spurt in new auto sales, according to estimates by Atlanta-based auto auction firm Manheim and Reuters.

So, what do you do when you"re industry is being threatened with a massive oversupply situation that could wipe out all pricing power for years to come?  Well, since reducing production is simply not tenable, one group of used car dealers in Wisconsin has an alternative solution...delay the problem for as long as possible by starting up a new used car leasing program. Per Ward"s Auto:

In a pioneering move, the 10-store Van Horn Group now leases used cars.

 

The 10-store dealership group in Plymouth, WI, began doing it to serve more customers and expand its pre-owned vehicle inventory, says Mark Watson, vice president-variable operations.

 

Used-car leasing is something of a rarity. But more and more dealers – such as George Glassman of the Southfield, MI-based Glassman Automotive Group – say it’s a good idea whose time has come and manufacturers should get behind it to help remarket waves of vehicles coming off-lease. That number is approaching 4 million a year.

 

“We are trying to create with used vehicles a unique position, one that allows us to put the client into more vehicle at a lower payment through a lease,” he says.

 

“Used car leases are an additional revenue opportunity and keep relationships strong with the bank,” says Tonya Stahl, Wisconsin Consumer Credit’s vice president-operations. “It helps us exceed customer expectations by providing flexible finance options for a successful and continual business relationship.”

Of course, while Van Horn"s used car leases provide a great opportunity for him to "double-dip" by effectively selling his used car inventory twice, it does very little to address the underlying problem of oversupply aside from marginally expanding the pool of potential buyers by lowering monthly payments.

Moreover, as Wards notes, used car leasing is not necessarily a new phenomenon as it has historically popped up during previous economic cycles when the auto industry faced similar problems.  That said, in past cycles at least, the concept was quickly scrapped after banks realized it"s nearly impossible to accurately underwrite the risk on a used vehicle when you have absolutely no idea how badly the car may or may not have been abused by it"s first owner.

Used-car leasing is not a new idea, although in the past it has been promoted sporadically, at best.  Could used-car leasing now become more mainstream, with a combination of the right new technology and, to put it bluntly, the renewed motivation to forestall a residual-value crisis?

 

Back when I was in auto retail, some banks did used-car leasing, as some captives do now, and some retailers did well with it, but it was not sustained by financial institutions.

 

Used-car lease retailers were hard to find, and not that well promoted. Worse, if trying to calculate a new-car lease back then was difficult (we are talking 1980s and 1990s), cyphering a used-car lease was pretty much impossible.

 

Unlike a new car, every used vehicle is unique, with a unique payment and residual (and forecasting wasn’t as sophisticated back then). Of course, we didn’t have automated vehicle-history reports (so some finance institutions were the victims of fraud on occasion, which no doubt led to the demise of used-vehicle leasing programs.

In the end, of course, this just moves most Americans one step closer to eternal financial hardship as profits are increasingly consolidated into the hands of monopolistic financial institutions who are all too happy to make you think that lower monthly payments are a "great deal" for you when in fact they only serve to insure that you never build any wealth and you never actually own any assets.

Auto OEMs And Auction Houses Are Colluding To Prop Up Used Car Prices; It Won't Work

We"ve written frequently about the pending collapse in used car prices that will inevitably be brought on by a surge in leases over the past 5 years.  With wages stagnant and car prices rising, the only way Americans could "afford" those brand new BMWs and Mercedes was to lease them.

Of course, the math behind how we got here is fairly obvious.  The majority of Americans buy cars based on one factor: monthly payment.  And when it comes to managing your monthly payment to the lowest level possible, leasing is the way to go.  Per the Bank Rate calculator below, buying a $30,000 car comes with a monthly payment of around $600 while leasing the same vehicle might only cost $420 per month. 

Of course, why buy a $30,000 Ford for a $600 monthly payment when you could lease a $40,000 BMW for $560?  You can afford it so long as you can cover the monthly payment, right?

Of course, the problem is that leased vehicles get returned to their originating lenders every 3 years for brand new leases...we wouldn"t want anyone driving around in a 5-year-old clunker now would we?  But, as we all know, vehicles have useful lives well in excess of 10 years.  Therefore, it doesn"t take too many excessive lease cycles to flood the market with used supply and bring the whole ponzi crashing down. 

Which is precisely why American auto OEMs are panicked about the coming wave of lease returns and why they"re colluding with auction houses to help keep used prices higher for longer.  According to Reuters, efforts to prop up used car prices include transporting cars around the country to markets where they"ll get the best pricing and basically sitting on inventory to restrict supply. 

So major carmakers, including General Motors Co (GM.N) and Ford Motor Co (F.N), are aligning with auto auction houses with aggressive moves to make sure they are getting the best prices for their vehicles. Such maneuvers include transporting the automobiles to where the greater demand is based on real-time pricing data, spending more to spruce up used cars and slowing the pace which leased cars get moved to used car lots or auction houses.

Auto auction houses such as Manheim in southeastern Michigan are where the romance of new car marketing goes to die. The dominant player in the U.S. auction market along with rival KAR Auction Services Inc (KAR.N), Manheim treats vehicles like commodities, grading them on a fine-tuned scale from one (poor) to five (excellent) that provides dealers with certainty and transparency.

Increasingly, the auction houses and automakers are collaborating to try to raise the scores, and the prices, of vehicles running through auctions. Auction houses have offered add-on reconditioning services on used vehicles for decades, but after the lean years following the Great Recession, demand is rising for those higher-margin services.

Of course, putting a rapidly depreciating asset in a storage lot, exposed to the elements, while waiting for prices to recover sounds like a "great" idea.

Meanwhile, a temporary re-balancing of inventory around the country could yield short-term benefits.  That said, we do wonder, if there was so much money to be made from selling used vehicles in different markets, why the OEMs just chose to forego those incremental profits until now.  Perhaps they were just making too much money?  Yeah, that must be it. 

For example, the national price for a 2015 Chevrolet Malibu with average mileage the week of June 11 was $15,514, according to data compiled for Reuters by car-shopping website CarGurus.

In Memphis, that Malibu cost nearly 9 percent above the national average fair price, but in Miami it would sell for more than 9 percent below that price, representing a difference of $2,700.

Manheim"s Matt Trapp, whose territory includes the U.S. northeast, says around 40 percent of vehicles coming off leases are returned to dealers within around five hours" drive of New York City. Many are now being shipped to other regions.

In New Jersey, for instance, one in three off-lease vehicles now leaves the state, Trapp says.

In the end, however, basic math and those pesky supply/demand models tend to work.  So, try as they might to delay the inevitable, we suspect used car prices will eventually succumb to the flood of inventory that"s about to hit the market.

"Flood Of Off-Lease Vehicles" Set To Wreak Havoc On New Car Sales

The percentage of new car "sales" moving off dealer lots via leases has nearly tripled since late 2009 when they hit a low of just over 10%.  Over the past 6 years, new leases, as a percent of overall car sales, has soared courtesy of, among other things, low interest rates, stable/rising used car prices and a nation of rental-crazed citizens for whom monthly payment is the only metric used to evaluate a "good deal"...even though leasing a new vehicle is pretty much the worst "deal" you can possibly find for a rapidly depreciating brand new asset like a car...but we digress.

Of course, what goes up must eventually come down.  And all those leases signed on millions of brand new cars over the past several years are about to come off lease and flood the market with cheap, low-mileage used inventory.  As Reuters noted, the flood of used vehicles is already starting to impact used car dealers:

Recently, though, a computer search for available used vehicles within 150 miles of Reel revealed an eye-popping figure: 668 Escapes. That"s enough to put more than 40 percent of the inhabitants of this small northeastern Ohio town, population 1,600, into the popular crossover.

A search for the Chevrolet Equinox, a comparable crossover, showed 461 available.

"The automakers have flooded the market," said Reel, owner of Reel’s Auto in Orwell, Ohio, about 40 miles east of Cleveland.

By the end of 2019, an estimated 12 million low-mileage vehicles are coming off leases inked during a 2014-2016 spurt in new auto sales, according to estimates by Atlanta-based auto auction firm Manheim and Reuters.

And, of course, that kind of supply is already starting to take it"s toll on used car prices...

Chief Executive Mike Jackson said rising off-lease car numbers means "a higher supply of pre-owned vehicles at a more attractive price.”

Consumers seeking great deals are in luck. Used-vehicle prices at auction fell about 3 percent last year, according to Carmel, Indiana-based KAR Auction Services Inc (KAR.N), which facilitated the sale of 5.1 million used and salvaged vehicles in 2016. Used prices should drop around 3 percent annually for the next couple of years, according to KAR"s chief economist Tom Kontos.

General Motors Co (GM.N) and Ford Motor Co (F.N) say prices for its used vehicles, which consist largely of nearly-new ones coming off lease to consumers, fell 7 percent in the first quarter versus the same period in 2016. GM says it expects a 7 percent decline for 2017 compared to last year.

...and, as Morgan Stanley recently pointed out, we"re just getting started as they see used car prices dropping by up to 50% over the next 5 years.

So what happens next?  Unstable used car prices will almost certainly reduce OEM reliance on leases as the implied 3-year depreciation (or residual values, if you prefer) will make them all but completely uneconomical...remember, Americans only care about that monthly payment.  Meanwhile, the relative value between used and new cars will tilt heavily in favor of the used market.  Thankfully Americans will still be able to buy that Mercedes they require to get back and forth from their minimum wage jobs, while maintaining a monthly payment of $500 or less, but it will just have to have 30,000 miles on it.

Of course, the OEMs of the world won"t admit that their game is over until it"s way too late.  So, they"ll keep right on producing new cars to cover a 17-18mm SAAR environment up until the point they face an outright revolt from their dealer networks.  At that point, however, dealer inventories will be so high that Detroit will be forced to shutdown for months on end while new car prices are slashed to reduce the massive inventory glut.  Tanking new car prices will put even more pressure on used car prices which will mark the beginning of the death spiral that will result in a new round of inevitable auto bankruptcies...but that"s just a hunch.

Is This The Sound Of The Bottom Falling Out Of The Auto Industry?

Authored by Wolf Richter via WolfStreet.com,

Not quite, not yet, but it’s not good either.

Let’s hope that the problems piling up in the used vehicle market - and their impact on new vehicle sales, automakers, $1.1 trillion in auto loans, and auto lenders - is just a blip, something caused by what has been getting blamed by just about everyone now: the delayed tax refunds.

In its March report, the National Association of Auto Dealers (NADA) reported an anomaly: dropping used vehicle prices in February, which occurred only for the second time in the past 20 years. It was a big one: Its Used Car Guide’s seasonally adjusted used vehicle price index plunged 3.8% from January, “by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble.”

The index has now dropped eight months in a row and hit the lowest level since September 2010. The index is down 8% year over year, and down 13% from its peak in 2014.

The price decline spanned all segments, but it hit the two ends of the spectrum — subcompact cars and the luxury end — particularly hard. The list shows the change in wholesale prices from January to February in vehicles up to eight years old:

NADA blamed three factors:

1. The surge in new vehicle incentive spending. Automakers, drowning in unsold inventories on dealer lots and desperate to move the iron and keep their plants running, increased incentive spending by 18% to the highest level in over a decade. This made new vehicle more competitive with late-model used vehicles. So this would be on the demand side.


2. The growing flood of used vehicles going through auction. Over the first two months this year, volume of vehicles up to eight years old rose by about 5% year-over-year. Volume of late-model vehicles – the supply from rental car companies and lease turn-ins – jumped 10%. So that’s on the supply side.


3. The IRS tax refund fiasco. Restaurants, retailers, and others are already blaming various February debacles on these delayed tax refunds. After the IRS was hit with millions of fake e-filed tax returns last year that claimed the Earned Income Tax Credit and the Additional Child Tax Credit, Congress required the agency to delay sending out refunds this year.

It’s big money. According to the IRS, refunds issued through February 10 plunged 69% from the same period a year ago. That’s $65 billion that didn’t make it into consumers’ bank accounts. But then the money was unleashed. In the week ending February 17, the IRS sent out a record $74 billion in refunds. By the week ending February 24, refunds were down only 10%, or $15 billion, year-over-year. So most of the problem was resolved by the end of February.

That might explain part of the problem on the demand side, at least at the lower end of the scale. But it’s hard to explain the plunge in prices at the luxury end. Also, these are wholesale prices. They don’t react instantly to a brief consumer cash crunch caused by tax-refund delays, now resolved. Something else appears to be going on.

The report, in attempting a forecast, cautioned:

February’s unusually soft showing makes pinpointing where used prices will go over the next few months a bit more challenging. However, given the slower than usual rollout of federal tax refunds, it’s assumed prices will be somewhat stronger in March and April than originally anticipated.

The Used Vehicle Index by Manheim, the world’s largest wholesale auto auction, didn’t pick up a massive drop in used vehicle prices over the past few months, though it too is showing some weakness. The index edged down 0.2% in February. The report pointed out that, “given a sharp decline in pricing in February of last year, the Manheim Index now shows a year-over-year gain of 1.1%.”

The index has dropped in six of the past seven months (chart), but in small increments, and as it says, “stability remains the watchword.” It too acknowledge headwinds for the market, including the “heavy new vehicle inventory and incentives,” and “a crazy tax refund season.”

Why are used vehicle wholesale prices important?

For one, they matter to lenders. Used vehicle wholesale prices determine the value of the collateral for $1.11 trillion in auto loans that have boomed on higher prices, higher unit sales, longer maturities (the average hit a new record of 66.5 months in Q4), and higher loan-to-value ratios (negative equity):

Dropping wholesale prices increase loan losses for lenders as recovery is lower. Declining wholesale values of lease turn-ins, if the trend persists, impacts how finance companies structure the lease terms, thus raising the costs for the customers and putting a damper on leasing activity.

All this puts pressure on new vehicle sales, further pushing automakers to pile on even larger incentives in order to move the units, grapple with inventories, and keep plants open. This works for a while – there’s nothing like big-fat incentives to bring out reluctant buyers. But incentives, when everyone is doing them, are front-loading sales. This is ultimately self-defeating and gets very costly even as sales begin to decline. It was a contributor in the collapse of the industry during the Financial Crisis.

And there are well-established patterns of customers switching between new vehicles and late-model used vehicles. Large incentives by automakers put pressure on late-model used vehicles. In turn, falling prices on the used vehicle side cannibalize sales from the new vehicle side. In other words, they compete with each other, often on the same dealer lot. Especially if demand is lackluster despite the incentives, these patterns can trigger a downward spiral that is difficult to get out of.

First oil & gas, then construction, then new vehicle sales. Read…  How Auto Sales Are Getting Crushed in Houston