Bark's Bites: Used Car Pricing Isn't Going Anywhere

As we reported just the other day, analysts are somewhat confused by the continued rise of used car prices to near-record highs, despite a flood of lease returns hitting the market.

This just goes to show you the stupidity of most people who call themselves “analysts.” There’s absolutely no reason to think that used car pricing will go anywhere but up in the near future. If these analysts had ever spent a single day in a used car department at a franchise dealership, they’d understand why. Unfortunately, they haven’t.

But guess what? Your friend Bark has! And I’m here to tell you why this used car bubble isn’t going to pop any time soon.

The analysts have one thing right: there is a flood of lease returns coming back into the marketplace now, and we’re just starting to see the beginning of that irrepressible tidal wave. But why did those customers lease in the first place? Payments, duh.

Creating a lease special doesn’t involve any voodoo. In fact, we’ve discussed how these payments are calculated before. If there are 50 $99-a-month lease specials coming back to the dealership this month, guess what? Those residual values are going to be sky-high — almost ridiculously so. Do you think the average Cruze has depreciated more than $2,400 in value over 24 months? I’m going to take a wild guess and say yes. (Of course, I don’t have to guess. Manheim reports back me up).

So who’s going to take the hit on the difference between the actual value of the lease return and the residual value? Why, it’s the bank, of course. And they’re not happy about it. So they’re going to do everything they can to get that customer back into another lease, which likely means another sweetheart deal and that you’ll keep seeing these types of lease specials for the foreseeable future. It’s a horrific long-term play — you can’t keep borrowing from yourself forever — but in the short-term, it keeps metal moving and money factors low.

Ask a used car manager what this ongoing lease bubble does to his pricing. Here’s what you’ll hear:

We have to pay way too much at auction for these cars because the banks are flooding the lanes with this low-mileage, lease-return inventory, so that’s all that’s available. We can’t buy a late-model Honda, Toyota, or Subaru for any less than we can buy a new one. So we can’t make any front-end gross.

And in the rare case that we do get a used car customer, they see that they have to pay $375/month for a used Cruze, or they can pay $87 a month for a new one. Which one would you pick?

So the average person on the street might think that the inability to sell used cars quickly would lower the prices, because we all understand how supply and demand works, right? Wrong.

If used cars sit, most dealers get scared and actually raise prices. If they can’t make their nut on volume, they’ll do it on gross. Let me break it down.

General managers typically don’t give a damn about number of used units sold; they get paid on bottom-line revenue, not top-line. So if they’re only selling 50 cars a month and not the 80 they’d like to, they’re okay with that as long as they’re making $4000 a car. So the fewer cars they sell, the more money they try to make on each car. Hence, used car pricing stays high.

So because lease returns have high residuals, they actually cause used car prices to go up, not down. And since we know that used car prices are higher in relationship to new car prices than they’ve ever been, we also know that more shoppers are going to buy new than ever before, too, which means that used car managers and general managers will continue to get nervous and try to hold gross on the front end.

If you understand the car business, this will all make perfect sense to you. If you’re an analyst who lobs grenades from outside the fold, you’re mystified.

And that’s why you should be careful about what you read and who you read it from.