Differences Between Good and Bad Car Leases

There are right ways and wrong ways to lease vehicles, says Tom Webb, chief economist for Manheim, a remarketing services company and auto auction chain.

The wrong way leads to residual losses that splatter a lot of red ink. That happened in 1999 when leasing volumes were at a then-record high of 3.7 million units, but forecasted residuals fell far short of actual values when vehicles came off lease in two or three years.

Back then, industry cynics said it wasn’t whether there’d be a leasing residual loss on any given unit, because losses were everywhere. Rather, it was how much the loss would be. Some were horribly high.

Webb calls it “leasing gone wrong.”   

Leasing bottomed out at 1.1 million in 2009, the result of the financial collapse that pushed General Motors and Chrysler into bankruptcy and put a stranglehold on funding access for all lessors.

In recent years, leasing has made a remarkable comeback, and with a more responsible business model. It surpassed the 4 million-unit mark in 2015 and hit 4.4 million last year, 30.1% of deliveries in the U.S.

Webb says there are concerns, but not nearly as many as the bad old days. What makes a good lease for automakers and other participants? 

“It’s basically the car, the customer, the residual and the remarketing practices,” Webb tells WardsAuto.

For lessors, “you want to want a car you are not uncomfortable getting back in three years,” he says.

The bad practices of yesterday included subventing leases as a way to move dog vehicles. Doing that as a standard practice ultimately leads to a financial day of reckoning.

“In terms of the customer, it’s one who wants a trade on a 3-year cycle and doesn’t want to assume the residual risk,” Webb says. It’s not a credit-challenged person who leased because he or she couldn’t get financing to purchase a car.

Ideally, lease customers have high credit scores, and for the most part they have had that of late, Webb says.  

“As for the residual, sure you are going to subvent a little bit (by automakers’ captive finance units), but you have to do it responsibly and knowingly,” Webb says. “If you are smart, you reserve for it, because you know you are not going to get it back.”

With the remarketing process, “you start from day one,” Webb says. “You don’t get surprised and say, ‘Hey, in three months, I’ve got all these vehicles coming back.’ You are thinking about these things ahead of time.”

As for the remarketing process back in 1999, “To be honest, there wasn’t one,” Webb says.  

So are most leases today good leases?

Webb replies, “That movement between what I would expect the real residual value would be when it comes back vs. the contract residuals, yeah, it’s widened out.

“A lot of that is because residual values largely are based on looking in the rear-view mirror. So they’ve been strong, and people think they will continue to be strong. They haven’t made that downward adjustment as much as they should have.”

Yet residual risks are part of all vehicle transactions, whether they are retail finance contracts, leases or cash deals, he says. The only difference is over who assumes the risk. 

There are preferable ways to subvent, or incentivize leases to make terms competitive, Web says.

Captive finance companies “to a large extent are doing it by putting the capitalized cost upfront,” Webb says. “They’re paying now rather than later. That’s a good idea. But it’s getting a little aggressive. We’ve seen pullback already, most notably with Ford.”

According to J.D. Power, leases last year accounted for 23.8% of Ford light-vehicles deliveries in the U.S., compared with 23.5% for Fiat Chrysler Automobiles, 27.6% for GM, 33.8% for Honda, 29% for Toyota and 28.1% for Hyundai/Kia, which are relatively new to leasing.

Lease rates in the luxury segment usually are twice the industry average. Accordingly, they were 62% for BMW and 54% for Mercedes-Benz.

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