Leasing Out of the Doghouse

Leasing is out of the doghouse, re-emerging as friendlier and better disciplined.

“It's coming back,” says Buzz Doering, a former dealership principal, now a leasing consultant. “It's getting hot now.”

But not too hot to handle, as was the case previously, and why so many lessors backed off leasing after getting burned by losses from overestimated residuals on off-lease vehicles.

Gone are the go-go days of the 1990s when leasing was wildly popular, peaking in 1999 with 3.7 million vehicle deliveries.

Then the decline started, as off-lease residual losses mounted and auto makers used hefty incentives to spur outright vehicle purchases. By 2003, leasing had dropped to 2 million units.

Since then, leasing has been nudging back up. In 2005, 2.4 million vehicles were leased. That is expected to increase this year.

“Leasing is an alternative when affordability becomes an issue, and as a result we expect to see leasing go up,” says Paul Taylor, chief economist of the National Automobile Dealers Assn.

In regaining popularity, leasing has become more disciplined compared with the bad old days, which at the time seemed pretty good — at least for a while.

Back then, auto makers subsidized leasing to move the metal by offering low monthly leasing payments. Those were based, in part, on overly optimistic forecasts of what vehicle residual values would be at the end of leases. Big losses occurred as predicted values collided into real values.

It was not uncommon then for 70% or more of new lease contracts to be written with residuals three or more points higher than Automotive Lease Guide (ALG) guidelines, says Tom Webb, chief economist for Manheim Auctions.

It's different now.

Residual predictions have become more realistic. In addition, fewer residual-unfriendly aftermarket vehicle enhancements are put on leased vehicles. There also has been a firming up of wholesale used-vehicle prices.

All that has meant that lessors last year “sometimes enjoyed end-of-term units coming back with market values above the contract residual as opposed to thousands of dollars under,” says Webb.

A mistake of incentivized leases in the past is that the wrong customer often was put into a new car.

Says Webb: “Instead of with the ideal person — one who likes to trade on a regular cycle and avoid residual risk — subvented leases often ended up with the customer who couldn't qualify for the retail loan on the same vehicle.

“That is no longer the case, as more than half of all leases written since 2002 have been to customers with credit scores of 720 or more.”

In contrast, only 37% of top credit-tier customers leased vehicles in 1997 and 1998.

Webb says incentivized leasing back then unwittingly hurt customer satisfaction and brand loyalty.

“The use of overly aggressive lease subvention to simply push metal often forced the lessor to offset the artificially low monthly payments with unrealistic mileage limits, large mileage penalties or excessive early-termination fees.”

In contrast, today's lease contracts “are more likely to be drawn up to fit the driving habits of the individual lessee,” says Webb. “And with residuals set more closely to market values, there is less need for a large early-termination penalty.”

Leasing is recovering because of more disciplined residual forecasting and other remedies, says Kelly Mankin, vice president-Chrysler Brands Marketing for DaimlerChrysler Services North America LCC.

“A lot of dealers have reacquainted themselves with the benefits of leasing,” which include a shorter trade cycle and higher gross on more expensive vehicles, he says.

Mankin sees leasing's re-emergence as helping to defuse “the single-biggest time bomb in the business” — consumer negative equity.

That is when a customer owes more on an auto loan than a purchased vehicle is worth, as the vehicle ages and depreciates in value.

“It happens when someone goes for a low down payment and a low monthly payment without regard to the length of the loan,” says Doering.

That has led to 84-, 96- and even 108-month loan terms, which, in turn, leads to negative equity. It also takes a customer out of the market too long, says Mankin.

And it hurts customer loyalty, he says. “We've studied loyalty and found that it is strong with a 36-month loan and lower at 60 months. Imagine what happens at 108 months.”

There is a way to offer a relatively low monthly payment without protracted terms, says Doering. “It's called a lease.”

Mankin agrees. “Leasing is the only logical alternative to the growing problem of negative equity,” he says.

But because of leasing's bad-dog past, many people are apprehensive about it, says Mankin.

“Dealers have to educate the sales staff to sell leasing up front,” he says. “It needs to be explained to customers. It is not applicable to every customer nor every product, but it can drive profits and margins.”

A traditional turn-off for many consumers is that leasing carries financial penalties for excessive mileage. High-mileage drivers hate leasing, says Jim Ostermann, a 30-year veteran of General Motors Acceptance Corp., who now owns a training firm specializing in leasing.

But he contends many vehicle owners also incur high-mileage penalties “in the form of negative equity because cars depreciate based on miles driven.”

Some vehicle shoppers also steer clear of leasing because they prefer vehicle ownership. But with negative equity on the rise, Ostermann says, “I ask customers, ‘When do you own your vehicle now?’”

He admits he's partial. “I love leasing,” he declares.

Doering, who started Doering Leasing Co. in 1966, says it benefits customers and dealerships if every shopper is given a lease presentation — not as a last resort and not with prejudice.

“You'll sell more vehicles,” he says. “A lot of dealerships try to sell the car first, then try leasing. Many customers would lease if they understood it. You can't present it as another way to buy a car, because it is not another way to buy a car.”

Leasing benefits include a sales-tax savings in 38 states, more vehicle for the money, a shorter trade cycle with a paid-up contract in three or four years and usually a spike in customers' credit scores.

Doering touts those but avoids over-promising.

“I've leased 10,000 cars, and I've never said leasing is better or cheaper,” he says.