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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.

Comments

  1. 1. Kevin Ellis [ October 22, 2013 @ 03:56PM ]

    I really don't see this being a big problem. We are selling more cars #1, and dealerships are employing more people and the manufactures are building more cars and more people are working, the banks are buying more lease paper and employing more people...The pre-owned market is booming and the prices on used cars are consistently going up all over the country...There are going to be losses and profits on these lease turn in's no matter what the residuals are, and that is already calculated into math... We need to focus on selling more cars let's keep this business rolling, this business has been a bright spot in these hard economical times. Supply and demand will dictate future pricing, nice late model pre-owned cars bring lots of money and they will continue to do so in the future, especially with the CPO market, no need to worry, everything will get sold that's how we make money!.

  2. 2. Matt Payne "the credit c [ October 23, 2013 @ 08:52AM ]

    Any one remember the original Ford "Red Carpet" leases. Sounds like were drinking the cool aid again. I'm not lease bashing I think we have come a long way, and I believe leasing is a great option for a lot of us. We just have to be smart.

  3. 3. Dave Brown [ October 26, 2013 @ 09:34AM ]

    RE: Kevin Ellis comment. The same argument can be made about the housing market and loan industry a few years back. Sales up, employment up, market booming...

    How'd that work out for us?

  4. 4. Scott R. [ October 27, 2013 @ 03:09PM ]

    The Industry creating another bubble.....Special Finance Cos already created another one...buying stupid! Mortgage loans next...again! FALSE SALES!

  5. 5. Randy Miles [ November 04, 2013 @ 05:57AM ]

    I have been the leasing manager at a Toyota store for 28 years. Only 1 in 5 leases ever go to term. So, your 'loss' estimation is way too inflated.

  6. 6. Mike O'Daniel [ November 17, 2013 @ 06:36AM ]

    I don't agree. First there are totals, early trades, and lease end buy outs that lower the percent of leased vehicles that are returned. Then you have retuned vehicles sold to the termination dealer. Then you have fees for mileage and condition that lower the lease end investment of lease end returns. I think 15% is safe. The trick is to increase the take rate at the termination dealer level and decrease the number going to auction.

 

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