CNW: Leases Overestimating Future Residual Values
October 22, 2013
BANDON, Ore. — The drive by automakers to increase their leasing share is putting them on a track to lose between $5 billion and $8 billion within three years, CNW Research reported this week.
Leasing has become increasingly important to new-car shoppers, and automakers are putting many customers into short-term leases. But the competitive nature of such lease deals is causing many automakers to overvalue future residual values by 5 to 10 percent in order to get monthly payments lower, according to CNW.
“While some overestimation of residual values can be justified because of the repeat business, lower marketing costs and other factors, if overdone it generates unacceptably high losses when off-lease vehicles are sold either through auction or to the leasing dealer,” wrote CNW’s Art Spinella in his firm’s monthly newsletter, noting that lower money factors (interest) and higher residual values are two popular ways to decrease lease payments.
CNW estimated that overestimating residual value by seven to 10 percent can be justified, while anything larger will become a financial burden.
Lease contracts have been overestimating residual values by roughly 14 percent in 2013 with major increases in September and October (15 and 18 percent, respectively), according to CNW data.
“Putting that into perspective, a vehicle with a $35,000 lease value carrying a 50 percent residual value should be worth $17,500 at EOT. Upping the residual to 55 percent results in a hoped for EOT value of $19,250,” Spinella wrote. “That $1,750 difference turns into a $5.25 billion overestimation if the industry leases three million vehicles – which is likely this year.”
Residual values have already been subsidized by at least three percentage points, bringing the $35,000 vehicle to $16,450 at the end of three years. This means, with a 55 percent end-of-term residual and 3 million vehicles leased, the industry is facing a tab in excess of $8 billion, Spinella wrote.