Leasing seems too good to be true: Automakers keep new vehicles moving out the door, customers return to dealerships, and motorists can rent cars they can't afford to buy. Everybody wins. That's the theory, and at the moment it seems to be working.
But effects of the back-end of leasing -- when the leases expire -- promise to reverberate through the automotive market. Literally millions of leased cars will reach the end of their terms and come back to dealers during the next three years, with a direct impact on used-car prices and on new-car sales. The unknown is how much trouble they will cause.
Industry observers think the soaring price of new cars, now averaging $20,000, combined with a flood of late-model, mint-condition used cars coming back into the market off short-term (24- to 36-month) leases will hurt future new-vehicle sales.
National Automobile Dealers Assn. () Economist Tom Webb observes: "There are a lot of (used) vehicles going out the door for $15,000 to $17,000; three or four years ago those would have been new-car buyers."
Until now, demand for low-mileage used cars hasn't exceeded supply. But then the full force of short-term lease cars entering the used market hasn't hit yet. "We've seen some impact on new-car sales, but it's been negligible," says Burt Bachman, owner of Galpin Motors Inc. in North Hill, CA.
During the 1994 model year, 29.7% of new personal-use vehicles were leased, rather than purchased. The National Vehicle Leasing Assn. (NLVA) says it expects that number to swell to about 33% when final figures for the '95 model year are tallied.
"One of the main reasons it's growing is manufacturers have entered the process heavily, and they're subventing their leases and subsidizing their interest rates," says Rod Couts, NVLA executive director. As a result, he says, "they're boosting their residual values beyond what are realistic."
Residual value -- what the car is worth after the lease expires -- is the key to leasing. Manufacturers estimate that value and subtract it from the total cost of the car. Then the remainder is divided by the length of the lease -- normally between 24 and 60 months. That's the monthly rental fee, although most inaccurately call it a car note.
Consumers actually pay for the monetary devaluation of the car during the lease term. What's left -- the residual value -- is where automakers may be digging themselves a potentially deep and damaging hole.
For instance, if a lease stipulates that the residual value of a $20,000 car will be 50% but the value at end of term is 40%, the carmaker loses $2,000. Multiply that loss by hundreds of thousands of cars yearly and you get the attention of Wall Street.
In an effort to either gain or protect market share, automakers over the last three years quoted residual values that proved to be much higher than recommended by the Automotive Lease Guide (ALG). But the fluidity of the market saved them. Used car prices outpaced ALG estimates, rising almost 8% per year since 1992.
The ALG expects the rise in used car prices to slow, falling to 4% this year, 2% in '96 and remaining flat in '97 (see chart, p.68). So automakers who were aggressive in setting high residual values in 1992 and 93 are carrying some red ink on their books. And with the flood of short-term lease vehicles surging into the market, there's scant hope that used-car prices will continue to rise at an 8% clip.
"That's water under the bridge," says Doug Aiken, publisher of ALG. Manufacturers should be poring over their lease portfolios to see where they are in upside-down positions and putting in place plans to cushion the landing, he advises.
Carmakers have lease programs for various models that quote different residuals. The trick is to have more winners than losers in their portfolios. For the losers, carmakers are creating marketing plans to cut the red ink such as releasing the car with a realistic residual or selling the cars after extensive refurbishing to boost the used-car price.
Once the demand for low-mileage used cars is inet by short-term lease cars entering the market, however, the theory is they'll drag down used car prices. If that happens, automakers stand to take a bath because their returning lease cars will be worth a lot less than the residuals they set. "Everybody's kind of holding their breath, hoping that the thing works itself out," saysspokesman Tom Orme.
The folks atMotor Co., the industry's short-term leasing leader, apparently aren't worried. Ford's leasing experts think there is a large and growing demand for low-mileage, high-quality used cars - and that it's in its embryonic stage.
"Buyers of six- and seven-year-old cars are now going to buy these nearly new cars," says Richard Beattie,'s executive director of rental, lease and remarketing operations. "When you talk about 1-million-plus short-term lease cars coming back (this year) and growing to 3 million next year, relative to the 30 million (sales) a year used-car market, it ain't very much."
He may be right. But with leasing expected to account for one-third of new car sales in 1996, and rising to half during the next five years, every manufacturer has to have a full understanding of, and ability to handle, the used-car market. "If you try to do one without the other," Mr. Beattie says, you'll be in deep trouble."