Why Used Cars Could Get a Lot Cheaper Very Soon

A coming surge of used cars could mean bargains for buyers -- but automakers are worried.

Apr 27, 2014 at 2:31PM

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The leasing experts at ALG saythat the Chevy Camaro holds its value better than other cars in its class. Used-car values have a big effect on automakers' lease deals. Photo credit: General Motors.

Want a nice used car? You might want to wait a little longer.

According to statistics from used-car auction giant Manheim, about 1.7 million vehicles came to the end of their leases and entered the used-car market last year.

That's a low number, and short supplies have kept used-car prices high. But that number has already started rising -- and that means used-car prices could be coming down soon.

How new-car leasing affects used-car prices
Why do leases matter to the used-car market? If you go shopping for a typical "nice" used car -- one that's two or three years old, and has maybe 30,000 miles on it -- odds are that you'll be looking at a lot of cars that just came off-lease.

About a quarter of new vehicles were leased last year. Most of those will hit the used-car market when their leases are up, making their way through an auction network, like Manheim, to dealers around the country.

But back in 2010 and 2011, fewer new cars were sold at all, because many consumers were still recovering from the recession. And a smaller percentage of the cars that were sold were leased, because lenders were still being stingy in the wake of the banking crisis. Leases made up just 19% of retail new-vehicle sales in 2010, and 20% in 2011.

These are the cars that have been coming on to the market during the last year or so. It's why supplies have been tight, and used-car prices have been high.

But as the economy improved, more new cars were sold. New-vehicle sales in the U.S. were up 13% in 2012 and up another 7.6% last year. That means more used cars are coming. Manheim expects 2.1 million off-lease cars to hit the market this year, and says that could rise to 3 million or more by 2016.

This is good news for used-car shoppers -- but it's not so good for the automakers.

Why automakers are worried about the surge of used cars
Strong used-car prices have probably helped new-car sales during the last couple of years. After all, if a used model costs almost as much as a new one, you might as well buy the new one, right?

They've also helped in a less obvious way, by making leases on new cars cheaper. Lease prices are set using "residual values," which is an estimate of what the new car will be worth at the end of its lease. If used-car prices are strong, residual values will tend to be high -- and automakers can offer lower lease payments.

That's a big deal, especially in market segments where leasing is very popular, like luxury sedans. General Motors (NYSE:GM) has made a big effort to improve its residual values to help make its lease offers more competitive -- in part, by limiting discounts on its new cars. That will also benefit the owners of those cars, of course.

Improving quality also helps. Ford's (NYSE:F) residual values have risen as its models have improved, something that will benefit GM as it follows the same path.

But residual values will take a hit as more used cars flood the market -- and new-car sales could be hurt, as well, as low-mileage used cars start to look like greater bargains.

How automakers and consumers can benefit
Of course, the automakers are already thinking about ways to turn this trend to their advantage -- or at least to limit the disadvantage.

One way: certified used cars. Expect to see automakers find ways for their dealers to buy up more of the best used cars, so that they can be offered as "certified" with an extended warranty. 

That will help cushion the blow for the automakers (dealers pay automakers to participate in the certification programs), while helping to keep used-car prices somewhat strong. And these certification programs can give buyers who are nervous about used-car shopping some piece of mind.

But there will still be plenty of bargains out there -- for those who are willing to be patient for a little while longer.

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