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Used Car Prices In Trouble Because Of Leasing

The used car market has been thrown out of balance for the past few years, and one reason for this is auto leasing. What does auto leasing have to do with the used car market? 

When a car dealer, whether new or used, needs inventory for their lot, they cannot simply call a factory to request used cars, as no factory can manufacture used cars. For new vehicles, a Ford dealer can contact the factory and request new Ford F-150s or Mustangs, but there is no such option for used cars. 

So, where do used cars come from? One source for dealers is trade-ins. When someone trades in their old vehicle for a new one, the dealer can use that trade-in as inventory for their used car lot. However, by definition, the dealer will always have fewer used cars than new cars sold. For example, if a dealer sells 100 new cars in a month, they will only have a maximum of 100 used cars to sell.

However, not all customers trade in their cars when purchasing a new one. Some simply buy a car without a trade-in. This means the number of trade-ins available may be reduced, leaving the dealer with only 50 trade-ins, for example. Furthermore, some of those trade-ins may not be desirable to sell on the lot. They could be old and beat up with high mileage or newer but not fit the dealer’s inventory. 

For instance, if a Ford dealer received a Ferrari as a trade-in, they would not put it on their front line. Similarly, if a dealer gets a high-end Acura or a low-end Kia, they might only put it on their lot if it matches their demographic. It’s unlikely that customers would visit a Ford dealer to purchase a base model Kia.

Let’s say you have 20 or 30 trade-ins available monthly to sell on your lot. However, you’ll need to bridge that gap if you aim to sell as many used cars as new ones. With 20 or 30 nice trade-ins, you’ll still require an additional 70 vehicles per month to put on your lot. But where can you get these cars? 

The answer lies in auctions, and the two primary auction companies are Manheim, which holds auctions almost every day, and another company. These auctions acquire their cars from two primary sources: rental cars and trade-ins from people who buy new vehicles. After two or three years or a certain number of miles, rental car companies such as Hertz, Enterprise, and Avis sell their cars at auction, and dealers are there to purchase them.

Another significant source of used cars is off-lease vehicles. In the past, many new car purchases were made through leasing. When you lease a car for two or three years, you return the keys to the dealership at the end of the lease and may purchase a new vehicle or leave without making a purchase. However, when you return the leased car, the dealer does not always keep it. They may have the option to keep it, but often these cars also go to auction. Regardless, that lease turn-in becomes additional used car inventory. 

Nowadays, people are not leasing cars as frequently as they once did. Instead, they finance, pay in cash, or obtain loans from credit unions. We will discuss the reasons for this in a moment. However, the decrease in leased vehicles being returned to the market has significantly impacted the used car market, particularly regarding the quality of the used cars available.

Consider two cars: an off-lease vehicle where the previous owner drove daily and took care of it, likely receiving free maintenance during the first few years, and a rental car parked right next to it. Which one do you think is in better condition? 

Thousands of drivers likely drove the rental car over three years, and each driver may not have taken good care of it. They may have driven it recklessly, hit curbs, or driven over bumps, without giving much thought to maintenance. The rental car company aims to make the car last for two or three years and then return it to the auction. Therefore, they will only do the bare minimum maintenance required to keep it running, such as basic oil changes, rather than using high-quality synthetic oil and performing extra oil changes. The rental car company only wants to spend what is necessary because they do not own the car and will eventually dispose of it.

Leased cars were generally of better quality and inventory. Another advantage of leased cars was that they were often better equipped. When you rent a car, it is usually a base model with no extra options, and the color is generally basic, such as white, silver, or gray. However, when people purchase a car for personal use, they prefer a more customized, higher-end model with features like a sunroof, digital dashboard, and XM radio. On the other hand, lease cars were usually more basic, without a sunroof or high-quality wheels. 

Nonetheless, these off-lease cars were valuable inventory for dealers because they were more personalized. This factor was critical in the resale market.

What does this mean for the used car market? Well, dealers and used car marketers no longer have the same volume and inventory quality. As a result, prices for used cars have increased, especially for off-rental cars previously sold for mediocre prices. Now that they are the only option, these basic cars sell at higher prices. 

Meanwhile, off-lease cars, which are of better quality, are highly sought-after and sell for top dollar since they are rare. Instead of comprising 30 to 40% of the available inventory, these high-quality cars are now more like one in ten, making them like diamonds in the rough. To complicate matters, the lease buyout process has changed. In the past, at the end of your lease, you could opt for a lease buyout instead of returning the car to the dealership, but this is no longer the case.

Here’s an example: let’s say you had a lease buyout option of $20,000, a fixed amount at the end of the lease that you can pay to keep your car. This number was often higher than the car’s actual value in the past because leasing companies inflated the buyout option to reduce payments, making it more attractive to lease a car. However, with the wild fluctuations in the used car market in 2020 and 2021, many older leases had a buyout option of $20,000, while the car’s value might have been $25,000 or $26,000. 

Consequently, many people at the end of their leases chose to keep their cars instead of simply returning them to the dealership, as they realized the car’s value exceeded the buyout amount. As a result, more vehicles were kept out of the marketplace, further reducing inventory for dealers and increasing demand for used cars.

The new car market is highly competitive now, making it a seller’s market for buyers. Leasing companies no longer need to be as aggressive with their lease deals, resulting in a decline in the popularity of leasing. This, combined with other factors, has led to fewer new cars being leased, resulting in a shortage of high-quality, desirable used cars hitting the market. This shortage impacts both used and new car buyers, as many high-end, quality used cars have displaced new car sales. For example, someone might visit a dealership to purchase a new car only to discover a two-year-old off-lease vehicle with 20,000 miles that is just as appealing and less expensive. 

However, finding such a high-quality used car has become increasingly complex, as off-rental cars are generally not good quality. This has thrown the used car market into turmoil, making it challenging for dealers to acquire quality inventory.

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