By on August 25, 2016

Niedermeyer shares some truth with the PBS NewsHour

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.

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159 Comments on “Bark’s Bites: Used Car Pricing Isn’t Going Anywhere...”


  • avatar
    SCE to AUX

    Niedermeyer – FTW!

    • 0 avatar
      PrincipalDan

      (Animal House – DOUG) Neidermeyer: You’re all worthless and weak!

    • 0 avatar
      Russycle

      I thought that was Ed. Well played, Mr. Bark!

      I still don’t get it though. If all that used metal is so overpriced, and dealers are selling less of it and charging more…than there should be a stock of used cars piling up somewhere, and that can’t last forever. Someday that damn has to burst.

      • 0 avatar

        Because a good sales team will turn that one late model CPO loser deal (for everyone) into several new car sales before taking the loss on someone who refuses to consider new. Even if new deals are also skinny these days, you at least get the back end money from the manufacturer. Additionally most people trade in a car. It’s those 6-8 year old cars that the used car departments can make money. Sure some cost more than they are worth to get ready so they go to auction, but if you can find a car that only needs a little work to get a fresh inspection sticker then you make money there. Most dealerships keep track of all the profits in the deal until no more trades occur. Our shop starts with new stock numbers like “Car001” and then the car traded in on it is “Car001A” and so on. That way we can balance out some of the lower value deals but still keep track of the big picture. The CPO warranties attract some people and most folks still buy additional protection products, plus money is made with the banks for arranging the financing, but very often, the car itself is break even. That’s another reason you truly are out of touch if you ever expect to get a better deal telling the dealership that you’re paying cash. No back end money to be made on them. The cars aren’t sitting around, but there isn’t any value to add other than the warranty.

    • 0 avatar
      healthy skeptic

      I was gonna say…new stock photo for dealer transactions? Then I looked closer.

  • avatar
    JimZ

    In my experience, “analyst” means anything between “overpaid guesser” to “overpaid manipulator.”

  • avatar
    Jagboi

    At some point though, don’t you run out of people who will buy used cars when they can lease new for less? What happens when the flood of lease returns piles up and there are no buyers? Won’t prices be forced down eventually if there is dead stock sitting in the lot?

    • 0 avatar
      ajla

      That’s what I’m wondering. Nothing Bark laid out seems especially sustainable.

      • 0 avatar
        heavy handle

        It sounds just like a bubble. If things are as he describes, then used car prices will collapse eventually.

        We heard the same arguments about the housing market pre-2008. Prices can’t come down, because the banks won’t let it happen. Until they did come down, hard.

        • 0 avatar
          indi500fan

          Another offshoot of the Fed low interest rate bubble. If dealers had to pay “normal” rates to floor plan this iron, it would be marked down and moved out. If carrying costs are minimal, they wait for the sucker bid.

          • 0 avatar
            skor

            Except cars are note bullion that will keep indefinitely. Cars that sit around too long will need work before they can go out the door.

    • 0 avatar

      Over 30 percent of new car purchases are leases. That means 30 percent of used car inventory is coming back with inflated value. That’s enough to drive up prices significantly.

      It may not seem sustainable, but it has been for eight years. There’s no reason to think it will change unless you don’t understand the economics of franchise car dealerships.

      • 0 avatar
        operagost

        I think it will change because the laws of economics work. Supply and demand are one area that isn’t voodoo. Cars will still sell at auction for high prices– until they don’t, because lots are flooded with $15K Cruzes. So either the dealers will bid lower, or they will lower the prices and take a loss. Guess which one will happen first?

        These cars aren’t going to the crusher unless Hillary gets in and decides to do Cash for Clunkers 2: Electric Boogaloo just so she can claim she stimulated the economy.

      • 0 avatar
        heavy handle

        There was a shortage of used cars for the past 8 years. Cash for Clunckers got rid of a bunch, and low new car sales after 2008 made sure there weren’t enough late-model cars to go around.

        That’s done now. Used car supply has caught-up.

        • 0 avatar

          Smart shoppers make bad analyst, and from the comments here there are lots of smart shoppers.

          My avg used car shopper comes to me assuming they can’t afford new and probably want a 4-5 year old car as Bark said. Some want CPOs for the added warranty and to save money off the cost of a new car. Both these shoppers typically never research new car prices, so their knowledge is limited to that of window stickers. So long as nothing changes that assumption, in their minds, they are saving an awful lot of deprecation even buying a CPO at or above KBB or similar figures. Even if you’re using tools that track deals, you may well not have actually shopped those deals against new, so currently a really good deal on a used one won’t often beat a really good deal on a new one, unless it’s a car that just happens to deprecate quickly, but then you have to wonder sometimes…

          Now me the sales person doesn’t want you to go somewhere else. Even if I wasn’t writting my own deals, a sales manager doesn’t want you to either. So everyone is on board with cutting down the price of a new one make a really good deal for the customer. After all, new cars are pretty much commodities.

          Leasing residuals aren’t all THAT far off from current trade residuals. The banks don’t take big hits, and regardless of manufacturer supported or 3rd party, the banks do well from folks getting new contracts every 3 years, rather than ever paying the car off. And that’s really where it comes in. The profit is supported on the back end of every transaction. If you make $500 (made up number) on every deal with the bank, you can sell the darn things for a loss and still come out ahead. Dealers make their kickbacks too. Each time you buy you likely get a warranty or something other than the car. While the extra products are profitable, most customers really do gain a fair value or peace of mind out of them, so no one is getting hosed there (I mean, there are some places that will stick it to you sure).

          So at the end of the day, it’s the consumer who is propping up the used car market, and unless people stop buying cars, no bubble will break. Loans are longer, but values hold better, and vehicles last longer. If you don’t believe any of that, you have to look yourself in the mirror and say “I really need to start leasing while the going is good or else I’m being an idiot!”, and then, maybe you’ll be right AND get a good deal.

      • 0 avatar
        ajla

        But how are the banks and captive finance arms going to continually keep the ability to offer the sweetheart lease deals if the inventory turnover on used vehicles slows down as dealers work to maintain their margin?

        Won’t the residual loss eventually catch up to the people doing the financing?

        From what you wrote it sounds like there is a large (increasing?) number of new vehicles coming back on subsidized leases that require a high resale to keep banks happy along with a decreasing number of higher-priced used vehicles being sold by dealers.

      • 0 avatar
        JustPassinThru

        What I’m not following is why the private-sale market isn’t pushing prices down. Sure, the dealership network may be functioning like a cartel, because of all of them using the same financial data, the same parameters and buying from the same banks and leasing companies; but there should be enough private owners ready to sell and for lesser money to alter the monolithic price-fixing model.

        • 0 avatar
          baconator

          The private-sale market is basically the red-light district to the average car buyer. Especially true for the average car buyer with good credit and a 9-to-5 desk job – only a tiny sliver of that demographic can deal with the standard shenanigans of a Craigslist purchase.

          • 0 avatar
            HeeeeyJake

            I like this thought.

            I believe this is why more private party used vehicle transactions increasingly happen between acquaintances, friends, family, rather than the blind date that is a car and a seller without a “character history” if you get my drift.

            I noticed this phenomenon over the last several years where a very high percentage of people I knew bought their parents’ or relatives or friends houses. Seemed that, especially for people who didn’t want extraneous anxiety in a big purchase, chose to go with “knowns” rather than “unknowns”, or worse yet, scams/frauds/misrepresentation.

    • 0 avatar
      Scoutdude

      Yes, the reason that used car prices are so high is because demand is still keeping up with supply.

      • 0 avatar
        JustPassinThru

        And if that’s the case, more marginal buyers, who realistically should be in the used market, will glom onto loss-leader new-car leases.

        I see a bubble a-risin….

    • 0 avatar
      Felix Hoenikker

      Effin A

  • avatar
    sportyaccordy

    Heh, the banks taking back lease vehicles and essentially controlling the auction market is the key here. Interesting little racket they have going.

    For fun I looked up 14-15 Cruze retail prices…. $10-15K lol. What a disaster.

    • 0 avatar
      Scoutdude

      The banks don’t control the auction market. Fact is it is the buyers that determine the market price and they don’t give a crap about what the bank has the vehicle on their books for. They just care if they can buy it at a price point that will leave them their desired profit when they retail it.

      Sure the banks may put a reserve price on the vehicle that meets the cost they have on the books but that doesn’t mean a dealer will buy at that price.

      • 0 avatar
        sportyaccordy

        If banks don’t control the auctions, who does? They are the only ones benefiting from the high residuals, and as I understand it they are the ones who are taking the cars back at the end of these leases.

        • 0 avatar
          Scoutdude

          The dealers control auction prices plain and simple because the market value is based on what someone is willing to pay. If what a person is will to pay meets or exceeds what someone is willing to sell at then a transaction occurs. If the seller wants more than the buyer wants to pay no transaction takes place.

          Also the reality is that $99 a month Cruze lease doesn’t mean that the residual will be $2400 less than new because that $99 a month lease is being subsidized by the mfg one way or another.

          • 0 avatar
            Lynn Ellsworth

            So banks, manufacturers, and dealers are madly juggling – no wonder no one has time to be nice to the customers.

          • 0 avatar
            shaker

            Doesn’t that “$99/Mo lease usually have like a $3000 “cash or trade” requirement in the fine print?

          • 0 avatar
            MBella

            The dealers definitely control the auction price. The problem is that buy here pay here lots are willing to pay. Used car managers at big lots follow suit since they can finance the high mark-up. Too many people only shop a monthly payment.

          • 0 avatar
            slance66

            I’m with @Scoutdude on this. An auction is an auction. Dealers are bidding on these cars, nobody is setting a price.

          • 0 avatar
            Domestic Hearse

            Yes, and no.

            Yes, the bank does control the auction. There’s the first right of refusal purchase (or auction as it were) where the OEM’s captive finance arm offers its lease backs to the dealer body. Captive Finance arm is looking to mitigate losses, knowing they subsidized that lease and now the residual is above real-world transaction price. So the lease backs are priced accordingly high to the OEM’s dealers. They have a choice, overpay for the car and then try to make a profit on it selling it themselves, or allowing the lease-backs to go onto the open auction, where any dealer (their competition down the street, CarMax across town, etc) can buy these cars. Of course, the price is going to start to come down. So the OEM dealer is stuck: Overpay for the leaseback now and hope to make money on it as a CPO and with other F&I products, or watch it go to my competition at a lower price and now have to compete against it.

          • 0 avatar
            Scoutdude

            @ Domestic Hearse, sorry but no the banks are currently not in a bad situation regarding residual values for most vehicles. The statistics show that the hammer price is on average above the residual.

            They are willing to take less if the dealer where the unit was turned it will buy it then and there. That avoids all the costs of transporting it to the auction yard and the risks and other costs associated with it. It also frees up their capital quicker increasing their returns. So banks being banks and thus risk adverse they are willing to take less because it costs them less and gets their money earning money again sooner.

            If it is a captive finance company then if the dealer doesn’t take it then they will offer it to the franchised dealers. That is an auction like any other auction where the individual dealer sets the price he is willing to pay.

            If that fails to get a sale then they will send it through the general lanes at the auction where any dealer can bid. Again the individual dealer sets the price he is willing to pay.

  • avatar
    srh

    This is a nice meta analysis, but it ignores supply and demand.

    What you have just described is an increase in supply (lease returns). Unless there is a commensurate increase in demand, the price will drop.

    • 0 avatar

      I encourage you to read the part where I mentioned supply and demand.

      • 0 avatar
        srh

        I did. That section used the words “supply and demand” but it ignored the implication of supply and demand.

        To be more clear, dealers *will not* allow inventory that is not moving to pile up indefinitely. You may think they will, but they will not.

        If their inventory is not moving, they will stop buying new inventory. Auction prices will therefore drop.

        Supply and demand isn’t a guideline that can be ignored if it’s inconvenient for a used car salesman.

        • 0 avatar
          operagost

          Indeed. The hand waving was so fierce I could feel the breeze over here.

        • 0 avatar
          Scoutdude

          Yup the laws of supply and demand indicate that the price will drop when supply is increased and demand is held constant. So if the increase in demand keeps up with the increase in supply the price can actually stay the same or increase.

          That all assumes that there aren’t other forces involved.

          The fact that many people have started doing 2-3 year leases instead of the 5-6 year purchase does mean that the supply of 2-3 year old cars is going to follow that increase. However what is totally being ignored is the fact that also means that there are fewer cars coming back into the market that are 4-6 years old.

          So the guy looking for that slightly older car finds that supply has decreased and prices have likely gone up. So that pushes some of those 4-6 year old buyers into the market for those 2-3 year old cars increasing demand for 2-3 year old cars. Meanwhile the fact that the low supply has increased prices for those 4-6 year old cars will work its way back up the chain.

          So yeah it certainly sounds like the laws of supply and demand are being broken by an increase in supply not causing the price to fall, but that is only because the demand side is being ignored.

          Supply and demand in the real world are much different than the text book version that takes place in a vacuum of a narrowly defined market condition.

          • 0 avatar
            JRoth

            That’s pretty good. Not certain to be right, but it does capture a nuance of supply others seem to be missing. That said, two things:

            1. The person who used to buy a 4-6 y.o. car doesn’t have the $$ to buy a 2-3 y.o. one, especially at what seem to be bubble prices. But maybe banks are propping him up as well?

            2. What is the future of a car coming off a 2 year lease? Is that purchaser, who’s getting a car that is presumably in good shape by used car standards, and who’s currently paying a premium for it, intending to purchase a long-termer? Because otherwise the new lease is *obviously* preferable.

          • 0 avatar
            Scoutdude

            #1. It is a subtle shift. Yeah that guy that was planning to buy a 6 yr old car isn’t going to buy a 2 yr old car. But he may buy that 4 or 5 yr old car and that 4 yr buyer might buy the 2-3 yr old car.

            Low interest rates are certainly helping those used buyers afford more car as well. The other factor is the rise of “new car rates” for late model used cars. For example my credit union will give the same rate for those 3yr/36K or less used cars as they do on new. More than that and you are paying another 1/2 a point.

            #2 It certainly is hard to predict what the purchaser of the off lease vehicle will do. One thing I expect we will see more of is those off lease cars going back out for another 2-3 year lease.

      • 0 avatar
        Detroit-Iron

        I get that used car dealers are both corrupt and stupid, but an auction is pretty much the most efficient market of all. If the used car dealers don’t buy the glut of off lease vehicles at auction I don’t understand how the prices can magically stay inflated.

        • 0 avatar

          Because dealers need inventory. All it takes is one desperate dealer at the auction to screw up everybody.

          • 0 avatar
            Secret Hi5

            “Because dealers need inventory.” – But your article implies that dealers are NOT in great need of inventory.

          • 0 avatar

            Of course they do. They still sell cars, and they still need to replace them. Trade-ins on used cars only happen about 20-25% of the time. The rest of the inventory has to come from the auction.

          • 0 avatar
            Pete Zaitcev

            The desperate dealers don’t have an infinite supply of parking space, or even money for that matter – not forever anyway.

          • 0 avatar
            dal20402

            But isn’t the logical outcome of this scenario that the dealers build up a pile of used inventory, because everyone is buying new Cruzes instead of used ones, and end up not needing any more? At that point you’d expect auction values to tank.

          • 0 avatar
            28-Cars-Later

            I warned dealers months ago to dump their inventory if they were underwater on it. F them if they continued to sit on bread and butter stuff they had for months looking for that one rube. Turn over inventory you numbnuts, if not auction than intradealer wholesaling or even export.

            The issue is NOBODY has money to buy because the entire economic “recovery” is FAKE. Subprime would not be growing if people had jobs and disposable income. Whats it at now 25% of all sales? I thought I read nearly a third recently. That’s the sign of a healthy eCONonomy, tis true.

        • 0 avatar
          Scoutdude

          Yeah it won’t take long before a dealer runs out of money if he pays so much at auction that he can’t sell it at a profit. So either he stops or reduces the number of cars he is buying at auction or he reduces how much he is willing to pay so that he can make a profit.

          So the dealers are continuing to pay high prices at auction because they are able to sell them at a price that makes them a profit.

          Take that dealer that Bark implied would be find selling 40 cars a month at $4000 profit each, instead of 80 at $2000. Guess how that affects the number of cars he buys at auction each month. Hint it doesn’t increase.

    • 0 avatar
      bunkie

      The problem with the faith in supply and demand, is that it assumes a free and open market. These are *very* large players with the lions share of the transactions. That is, most definitely, a “free market”.

      Look at sub-prime lending if you want to see a real-world example. With institutional interest rates at historic lows, one would expect that *all* levels of the credit market would see a reduction in rates. That is certainly not the case in sub-prime. The current spreads are so large that even with 10% full-default rates, there is a lot of money to be made. Meanwhile, us regular savers have only the hope of the stock market to get any kind of a reasonable return on our money while, at the same time, credit card interest rates have not declined.

      • 0 avatar
        bunkie

        EDIT:
        That is, most definitely, NOT a “free market”.

      • 0 avatar
        George B

        Bunkie, numeracy isn’t evenly distributed throughout the population. When I buy a car I want to know the out-the-door price for just the car, but most consumers primarily want to know the monthly payment where the price of the car and the price of borrowing money are mixed together. As long as interest rates are low, monthly payments can be kept affordable even though the price of the car is high. Lenders are also willing to stretch out loans over longer terms than they did in the past, keeping the monthly payment within the consumer’s budget.

    • 0 avatar
      CH1

      “This is a nice meta analysis, but it ignores supply and demand.”

      Agreed. If used car prices remain high, despite increasing supply, then demand must also be increasing. So why is the demand for used cars increasing?

      I think it mostly has to with the fact we are still recovering from the Great Recession. The suffering caused by the recession increased from the top to bottom of the economic ladder, while the recovery proceeds from top to bottom. Thus growth in the used car market lags that in new cars market, as jobs and wage growth works it way down the economic ladder.

    • 0 avatar
      28-Cars-Later

      High supply = high price. Duh.

      ‘Merika

    • 0 avatar
      derekson

      The missing ingredient in Bark’s otherwise spot-on analysis is that demand is also staying up because of free and easy lending for used cars. Used cars are moving at high prices because banks are willing to finance them at those prices with little money down and to increasingly risky buyers This is a credit bubble just like the housing bubble was (and now is again, to some degree).

      Add to this fact that many ignorant buyers are coming in and only shopping a monthly price and the dealer can move the metal at a high price as long as the bank is willing to write the loan paperwork. They just reduce the monthly payment and draw out the loan to 60 or 72 months and BOOM we “magically made it work out for your desired monthly payment! Congratulations!”

  • avatar
    stryker1

    So it’s basically an unwillingness by the dealer to mark to market. I’m sure that will end well. Something something 2008…

  • avatar
    jmo

    “If used cars sit, most dealers get scared and actually raise prices.”

    Then they should just sit even longer. Unless there is collusion, customers will just go to a lot offering lower prices to move metal.

    • 0 avatar

      Someday I have to write about how vAuto works. It’s not collusion, but it’s awfully close.

      • 0 avatar

        I’ve been “following” some cars on Cargurus and have seen this in action. There’s 3 used Scion FR-S at 3 different dealerships that started out around $20,000 They’ve been on their respective lots for months now and have all been dropping in price at the same time and by roughly the same amount each time and are all down to around $19,000 right now.

        All it would take to sell one is the the price to drop $1,000 below everyone else, why doesn’t anyone do that? Maybe it’s collusion as you imply.

        • 0 avatar

          Because vAuto. Again.

          • 0 avatar
            shaker

            Great – now we’re actually going to have to physically visit dealers (on Sunday?) to see what their inventory levels look like to get an idea if they’re ready to undercut their supposed “competition”?

            Show me the “Aerial Photo”, Internet!

          • 0 avatar
            yamahog

            How does vAuto work? How does vAuto make sure that the supply of Scion FR-S doesn’t explode?

            I suppose vAuto could coordinate the market so the number of ‘new cars’ entering the used market reflects the number of used cars sold. But eventually someone is going to realize they have a chance to be a free rider.

          • 0 avatar

            I open myself and TTAC up to a whole bunch of litigation if I tell you how vAuto works in great detail. High level—it allows dealers to price their cars in comparison to the market. Very few dealers want to be the cheapest—they just want to be competitive. That’s why you’ll see a good number of the cars in a certain radius priced nearly identically.

    • 0 avatar
      yamahog

      ding ding ding.

      If a MY2013 Cruze doesn’t sell for $15k, why does raising the price to $17k make sense? Why not mark the used Cruze up to 117k and just hope to sell 1 car a month?

    • 0 avatar
      brettc

      I’ve been watching a 2013 C-Max off and on that’s at a local used dealer.

      Cargurus says it’s been listed for 145 days. The dealer had it down to $8990 in July, and then bumped it up to $9990 on August 10. Not the first time I’ve seen that either with the C-Max. They’re cars that not many people want at the moment, but my guess with the $1000 bump was that they figured they could sell it to someone going back to school for more money since they’ve obviously not making anything with it sitting on their lot since April.

  • avatar
    Point Given

    “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.”

    History never fails to repeat. If I recall correctly at one point during 07/08 meltdown GM was losing 1 billion per month on lease returns as residuals being too high versus market values.

    Even mentioned on TTAC back in 2008:
    https://www.thetruthaboutcars.com/2008/07/the-truth-about-leasing/

  • avatar
    Pch101

    In the long run, supply and demand should prevail. If there is a supply glut, then it will eventually get discounted because the sellers will have no choice.

    In the short run, “sticky prices” are likely to prevail. Market conditions may call for discounting, but most sellers will be reluctant to immediately cut prices. Individual sellers end up behaving as exceptionalists, believing that they can do better/higher/whatever because of some unique advantage that they possess. Or they may not have yet figured out that the market has changed, so it can take them time to react.

    Otherwise, there may not be a supply glut at all. Used car sales are strong, so the inclination to maintain higher prices may be justified. If the inventory is moving — I don’t know whether it is — then there will be no reason to cut prices. To forecast the future, I would calculate days of inventory.

    • 0 avatar
      Scoutdude

      Yes, as I mentioned elsewhere the laws of supply and demand are a lot more messy in the real world than in a text book and corrections in the real world usually are not immediate.

      • 0 avatar
        yamahog

        I don’t know what text books you were reading, but once you get into econometrics, the models map to reality pretty well and people understand exactly why the models don’t work.

        • 0 avatar
          Scoutdude

          I’m talking about the HS economics text book which matches the theory given in this article.

          • 0 avatar
            Pch101

            The argument being made by the article is that the sellers have the power to set prices. In essence, it is an oligopoly that is not pressured to compete on price because it can decide what the prices are.

            I haven’t crunched the numbers, but I personally doubt it. There are too many sellers of used cars for that to be the case.

            What seems more likely is that the supply has been well absorbed by rising demand, so price levels have been maintained. If there is sufficient demand for the lease returns, then that would explain the prices — there is more supply but it hasn’t outpaced demand, so there has been no reason for prices to be cut dramatically.

            This may be explained by the reduction in production capacity for new cars. One of the byproducts of the recession has been a considerable reduction in supply capacity. In the old days, this surge in demand may have triggered new vehicle production increases that are no longer possible. If OEMs are motivated to maintain residuals for their own sake (after all, they are participants in the leasing business), then they may opt to build fewer vehicles.

          • 0 avatar
            dal20402

            What PCH said. There has been a supply shortage in the used market and it’s now being corrected. If prices continue at the current levels, where new is more attractive than late-model used, then eventually there will be a glut. Once there’s a glut, at least some dealers will lower prices and the edifice will eventually tumble no matter how sticky some individual dealers are about price.

  • avatar
    Lynn Ellsworth

    I read your column 3 times and I still don’t get it. Someone has to bail out of this stupidity.
    Will it be the buyers who realize the prices are too high on used cars?
    Will it be the dealers who run out space storing unsold used cars?
    Will it be the banks who realize there is something wrong with their leasing rates?
    Probably not the banks, they were the dumbest in 2007 with housing prices.

    • 0 avatar
      fvfvsix

      What will happen will be the same thing that always happens, whether we are talking about finance, housing or cars.

      It’s called no-bid.

      When that happens, banks can no longer artificially shift prices higher, and they will collapse.

      • 0 avatar
        baconator

        This year’s Monterey auctions have already shown a pretty significant correction on high-ish-end cars. I’d imagine this is an early-warning signal.

        • 0 avatar
          thattruthguy

          The economics of retailing high-end art and collectible cars are different from consumables like late-model passenger cars, except for the vaguest “people have more (or less) money to spend on stuff.”. They’re purely speculative or pleasure purchases, so there’s no real price floor. OTOH, very few people have a good alternative to buying/leasing a personal vehicle for daily transportation. They may or may not maximize the value of their purchases, but they don’t have the option of opting out entirely.

    • 0 avatar
      JohnTaurus_3.0_AX4N

      I agree, something must give, sooner or later. I get the strongest feeling its gonna be hell on everyone. The housing bubble, the .com bubble, it’ll be along those lines.

      I hope I don’t have to be in that market anytime soon.

      Driving 20+ year old cars FTW!! Lol Good thing I don’t give a crap about what people think about me driving what they wouldn’t touch with a 10′ pole. At least *the next time* the world economy flat-lines, I won’t be dodging the repo man.

  • avatar
    yamahog

    Bark, I really appreciate your insight. I only step foot in dealerships to go to the parts counter and I’ve purchased exactly one car from a dealership in my life so please forgive my blissful ignorance but some of the things you said seem curious –

    “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.”

    If it was always more profitable to sell 50 cars a month with high margin, why wasn’t every used car manager already doing it?

    “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”

    Why are the cars so expensive at auction if the market is flooded?

    “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.”

    If the car didn’t move at its initial price, why would it move at a higher price?

    There’s a death spiral here: as the car sits, the sunk cost increases and the dealer becomes more reluctant to accept a low price for it. However, the dealer can’t raise the price infinitely. The rational thing to do is ignore the sunk cost in the sale of a given car, and use the information (e.g it’s a tough market for Chysler 200s) to inform their future decisions. But used car managers aren’t bond traders and used car dealerships enjoy serious barriers to entry so perhaps they can insulate themselves a bit against market forces. But bubbles collapse when the music stops and the music always stops.

    right now, it’s extremely telling that the market isn’t efficiently pricing cars if many people find it ‘cheaper’ to drive a new car than a used car. A new car should be more desirable / valuable to a given consumer and the prices should reflect that scarcity. I don’t know whether that means new cars are ‘too affordable’ or if used cars are priced too highly.

    • 0 avatar
      MrKiwi

      “here’s a death spiral here: as the car sits, the sunk cost increases and the dealer becomes more reluctant to accept a low price for it. However, the dealer can’t raise the price infinitely. The rational thing to do is ignore the sunk cost in the sale of a given car…”

      Yes and no. Step back for a moment, and at the simplest level you have fixed and variable costs. Economic theory says so long as you can cover your VARIABLE costs you can keep operating. The rationale is that you have to cover fixed costs whether you are selling or not, but variable costs can be avoided by shutting down.

      Important note, though, is that this is only sustainable in the short term. Pch101 is making some great observations, and I think there’s a lot of hand-waving going on in this article that someone who knows economics better than me can explain.

      • 0 avatar
        Pch101

        There is the issue of the “sunk cost fallacy”. People do tend to cry over spilt milk and attempt to recover their costs even if the effort could increase their losses. It’s not logical, but it is commonplace.

        That’s part of what drives the sticky price problem. It takes awhile for sellers to correct. We can plot out supply and demand on a chart, but most people won’t see that in real time when prices begin trending downward.

  • avatar
    notwhoithink

    You know, I really find most of Bark’s writing very informative, since I have that outsider’s perspective. But I just can’t get my head around what he’s saying, especially here:

    “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.”

    If it truly is an auction, how can the banks control the prices? Do they all come through with stupidly high reserves? Are they even allowed to have reserves on these auctions? If they’re flooding the lanes (market) with low mileage lease returns, the prices should be expected to drop without some sort of artificial support. And if you’re a dealer who can’t get a late-model Honda/Toyota/Subie for any less than a new one, then why would you buy the used one at all? Especially if customers would expect to pay less for them.

    Then there’s this line:

    “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.”

    I agree that you can’t, and when you finally can’t keep up with it anymore the bubble bursts and prices drop. I feel like Bark is admitting that eventually we will see the price drop, but “not today”. Maybe we’re not going to see used car prices dropping this November/December as some analysts have forecast, but it’s going to happen sometime. The only other alternatives would be a massive spike in demand (a baby boom of used car buyers?) or a massive cut in supply (a swarm of hurricanes destroying cars in all of the coastal cities?).

    • 0 avatar
      Jack Baruth

      My dealer experience isn’t as recent as Bark’s, but what I think he’s saying is this:

      * Used-car dealers NEED INVENTORY. If thirty percent of the auction traffic is coming through way overpriced, it drives up transaction prices on the seventy percent that isn’t initially overpriced.

      * “Sitting on inventory” is all relative. The difference between a dealer’s worst used-car month and his best is often just 25%. People still need cars, they’re still gonna buy cars.

      * And the late-model used-car business is completely weird. It doesn’t sell based on value; it sells based on the perception held by a lot of people that a “nearly new” car is fiscally sensible while an actual new car is not. Which is why you will see that transaction prices on, say, 2014 Corollas very closely matches the same dealer’s transaction on NEW Corollas.

      • 0 avatar
        srh

        I think what everyone else is saying is “Great. It might be an awful time to be a used car dealer. But very, very soon it’s going to be a great time to be a used car customer.”

        Someone along the chain is going to start lowering prices. Either the banks on their residuals, or the dealers off-loading the used inventory to auction, or the dealers selling to consumers.

        The one thing that is absolutely certain is that if supply increases, consumers will pay less.

      • 0 avatar
        DC Bruce

        I hear you, Jack; and I hear your brother, too. But still . . . it so happened that, in 2008, I was in this exact situation as a buyer. Our 12-year old Previa was ready to be put out to pasture and my wife wanted to make our 6-year old Saab wagon into “the kids car,” replacing it with something larger. We test-drove both the Highland and the Pilot; and she liked the Pilot better. That was the last year of the first-generation Pilot, so dealers were willing to deal on what they had in inventory. I researched the price of a 1 or 2 year old Pilot and found that, for very little extra money, I could get a new Pilot with warranty, etc.

        So, that’s what I did — an outright purchase, not a lease. At the time, I chalked it up to a lack of transparency in used car prices — despite KBB, etc. actual prices were perhaps a bit lower than they said–at least for those buyers willing to work at it.

        So, I’m having a hard time getting my brain around the concept that someone would prefer a 1 or 2 year old off-lease vehicle, even a CPO, to a new one at the same $$, whether a lease or an outright purchase. There are (or were) a few odd instances where buying a CPO, still under the original warranty would get you a total warranty (original + CPO) longer than the original, but that was the exception. (I think it was VW who offered this a few years ago.O

      • 0 avatar
        notwhoithink

        OK, that point about the 70/30 split makes sense, but there is a practical limit. As the sum of auction price + recon + profit reaches an amount that’s more in less in line with the price of a new car, people will shift to buying new. No rational customer (and I get that a lot of them are not rational) is going to pay $30k for a 2-3 year old car when they could have a brand new one of the same price.

        “Which is why you will see that transaction prices on, say, 2014 Corollas very closely matches the same dealer’s transaction on NEW Corollas.”

        Is that because used car prices are so high, or is it because dealers/manufacturers are offering deep incentives?

      • 0 avatar
        Jeff Zekas

        Well said, Jack. My son bought a new Tacoma, after realizing that the used ones were only a few thousand less. Used late model vehicles make no sense, from a buyer’s cost point of view.

      • 0 avatar
        slance66

        I get what Jack is saying, but I sense that there is more to the story. Leasing is heaviest among luxury brands, right? So what the market is being flooded with are BMWs and Audis and Lexus RXs.

        So that average consumer who is looking at nearly new isn’t shopping a 2 year Highland against a new Highlander. She’s shopping a 2-3 year old Lexus RX against a Highland. Add in CPO, giving these buyers the same warranty as the new car buyer of a “normal” brand, and you can see how these cars remain in high demand. CPO Audi A4 vs Camry. CPO RX350 vs Highlander.

        The combination of leasing and CPO creates a huge number of “used” cars that are much newer, nicer and safer for the consumer to buy than the old world where they bought 5-6 year old cars with no warranty.

    • 0 avatar
      Land Ark

      There’s a 3rd thing that could happen. If the value of used cars stays high, it wouldn’t be unheard of to see the cost of new cars rise to even things back out in the opposite direction.

      If I were Chevy and I see my used cars selling for the same as my original MSRP I’d probably think I need to adjust my pricing. Especially if demand hasn’t dropped for either.

  • avatar
    Alfisti

    Sorry Bark but none of this makes a lick of sense.

    You acknowledge a glut of used cars hitting the market then say that managers will price them high because they are happy to deal with profit rather than volume. Then you say people are still buying new because payments.

    That triangle cannot work, it’s impossible, if the customer is not buying the manager will be forced to drop the prices.

    So what is happening is new demand, or added demand, that does indeed see the customer willing to buy used at a high price but you don’t want to acknowledge it. No idea if this is population growth or an ageing national fleet with brighter economic prospects so there may have been deferred “near new” buyers, i dunno, all i know is that what you are saying is impossible, someone, somewhere is willing to pay or the manager would be forced to cut pricing.

    • 0 avatar
      Russycle

      Exactly. If dealers were selling 80 cars per month but now they’re jacking their prices and selling only 50 cars per month, then they’re going to be buying a lot fewer cars at auction. If cars aren’t selling at auction, banks have the choice of warehousing them or dropping the price. I know how much banks hate to take a loss, but I can’t see them getting into the car storage business.

      If the prices aren’t falling, somebody’s buying these cars.

      To be fair to Bark, he does say, ” we’re just starting to see the beginning of that irrepressible tidal wave.”

      So possibly inventories haven’t started piling up yet, or at least not enough to push pricing downwards.

    • 0 avatar
      Luke42

      This article is a perfect example of why economists talk about short term and long term effects.

      Bark’s argument is very convincing in the short term. I bet it explains perfectly what will happen over the next few months, and why.

      Over the long term, the balance of supply and demand almost has to be dominant.

      Remember that the “law” of supply and demand is merely an observation about how rational actors (not to be confused with actual humans) would behave in a perfect market with no information asymetry — but it likely does most apply here over the long term..

  • avatar
    fvfvsix

    Interesting perspective, but really misleading title. I clicked, so I guess it did its job.

    Of course, we will eventually get to a point where this game runs to an end… unless there’s a flood-ravaged area with an appetite for off-lease Cruzes (Baton Rouge, anyone?).

    Short of that, prices will eventually collapse spectacularly. I won’t bet on when, but the probability of this happening is pretty close to 1.

  • avatar
    Frank Galvin

    Bark – does subprime lending play a part in keeping this bubble afloat? I.e. something along these lines.

    Dealer has 10 Cruzes – all lease returns for let’s say 15k, and they’ve been there for a while. Customer comes in wanting an Impala / Equinox but can’t get GM financing for the new model even with some money down. Dealer either has in-house financing or can get approval from Cap One. Steers the customer towards the slightly used Cruze with remainder of factory warranty and voila! Sold and off the books. So, if they can afford to wait a bit, and have access to subprime financing – they can the units on the lot at 15k longer than normal. Is this part of what is keeping the “bubble” afloat?

  • avatar
    Jeff S

    If Bark is correct then FCA should be able to move all those Chrysler 200s and Dodge Darts by selling them as used and raising the price. I find this article a little hard to believe unless there is a scenario such as what Frank has presented. If what Bark states is true about its hard to get a sub-prime loan on a late model approved then why not buy new? I haven’t bought a used vehicle in years because I tend to keep my vehicles for over 10 years so I would rather have new. It doesn’t make much sense to buy a late model used vehicle if there is little or no difference in price over new. It seems to me that those who would qualify for a loan on a late model used would qualify for a low or no interest loan on a new model. Why buy used unless the vehicle is older and you cannot afford a new vehicle. For a little more buy a new vehicle with a full warranty that has not had a chance to be abused.

    • 0 avatar
      Big Al from Oz

      Jeff S,
      I see the US vehicle industry having a rocky road to traverse in the near future.

      If the consumer continues to grab a lease vehicle and the banks are losing money on previous lease vehicles the only other way to maintain used car prices is by rising new car prices. This means the banks will not lose out with poor auction prices.

      So, the alternative is a dying new vehicle market. This will hit the US manufacturers quite hard.

      The hardest his will be the non pickup manufacturers first. Cars and CUVs. Pickups tend to be a longer term purchase. So, I’ll give the Big 3 a couple years before they end up like the car/CUV manufacturers.

      I see the US auto industry in a sh!t fight.

    • 0 avatar

      If the 200 or Dart were at all desirable, that might work out.

      • 0 avatar
        notwhoithink

        I’m wondering if the fire sale discounts aren’t finally working. I rarely saw the 200s on the roads until this month, and now I see them everywhere.

  • avatar

    Niedermeyer was better

  • avatar

    And Bertel also

  • avatar
    Big Al from Oz

    I do believe what Bark has stated to be true to an extent. But, I disagree with the impact that very few dealers can maintain high auction prices.

    Look at any given market. There will be a small percentage prepared to pay “above” normal prices for any commodity. But, these people don’t drive the price of the commodity. They do have a slight influence.

    I foresee US used car prices dropping. The Banks will pick up the losses along with the vehicle manufacturing industry via less new car sales.

    What Bark doesn’t mention is if that car dealer now selling 50 used cars with a four grand profit instead of 80 with proportionally less profit there is a hell of a lot of used car “inventory” somewhere.

    Bark? Are you going to create an export market for all of these unsold used cars to maintain a supply and demand balance? Canuckistan looks like a viable market for used US cars.

    I just read the US Cheese industry just recieved a socialised handout. The US Government just bought 5 million pounds of over production. Why?

    Will the US government buy a lot of these used cars and crush them to maintain the car industry? I doubt it.

    Used car prices will drop and soon.

    • 0 avatar
      Scoutdude

      “Canuckistan looks like a viable market for used US cars.”

      Actually exchange rates over the last few years means that in the PNW we have seen a significant number of late model used cars imported from Canada. Note that comes with a little buyer beware because some people have found that the warranty wasn’t honored or the warranty coverage was different because it was originally sold outside the US.

      • 0 avatar
        Big Al from Oz

        Scoutdude,
        It was a tongue in cheek comment regarding Canada as a market. I’m highlighting the fact that there are only two ways the used car prices can be maintained.

        1. Export used cars to other countries.

        2. The cost of getting into new car will rise, either through harsher leases and loans and manufacturers increasing prices.

        Or, the most probable outcome is the banks will lose money. Used lease cars will sell at auction at a loss, thus, creating a smaller impact in the new vehicle market.

        I’d say both new and used cars will be affected. The short term gain of a few years in car sales is not sustainable for the future.

      • 0 avatar
        Big Al from Oz

        Scoutdude,
        The over the border car sales from the US into Canada will only get larger if the prices fall further on used car prices. Then, the sale of used cars into Canada will decrease as more are sold in the US.

        I don’t know how and why Bark has gotten this so wrong.

        • 0 avatar
          Scoutdude

          The cross border economy is interesting. Fact is a lot of things are much more expensive in Canada so a lot of people who live near the border come to the US. When I went to school in the town near the border it was normal to see the K-Mart parking lot littered with old shoes and clothes come Sun evening. Despite the fact that their dollar was worth 75-80 cents it was still cheaper to buy in the US.

          What goes on at the Costco in that town now is crazy. I’ve made the mistake of stopping there to get gas on a weekend. You’ll see new expensive cars pull up to the pump and the trunk/tailgate/hatch pop. The person will get out and start filling their car and as many 5 gal cans as they can carry. Personally I wouldn’t want to drive around with 25-30 gallons of gas in the passenger compartment or trunk no matter what the car was but certainly not in a new Mercedes/Audi/Lexus that I spent big money on.

  • avatar
    FormerFF

    I never see these low lease rates in my market. At the current time in my market, the lease offer on a Cruze LT is $199 per month for 39 months, plus $2479 due at delivery, for 10,000 miles per year. If you bump that to 12,000 miles per year and add it all together, you’re at $305 per month plus tax.

    A three year old Cruze with 40,000 miles in the same trim level as the lease offer car can be had for less than $13,000.

  • avatar
    fvfvsix

    After giving it some thought, Bark – I have the answer.

    Used car leasing.

    That’s how this bubble gets extended.

  • avatar
    John

    I’d be careful. What a dealer “needs to make”,”has to make”, “must make” to turn a profit matters not a whit to Mr. Market, in the long run. Many homeowners discovered that immutable fact in 2007 – 2009.

  • avatar
    jacob_coulter

    Not a convincing article.

    Eventually supply and demand wins. And what can’t go on forever, won’t. Even in the used car market.

    So even car dealers that “need” more money from fewer sales will eventually have to lower prices to move inventory if they can’t move their product. The idea that they will keep raising prices as volume falls is not based in reality.

    Some money is better than no money and they will price new inventory accordingly.

    • 0 avatar

      Not based in reality? Then why is it happening in reality?

      • 0 avatar
        Scoutdude

        Because demand is increasing at the same time for a number of reasons.

        • 0 avatar

          Demand for used cars is falling in comparison to new cars, and it has been for nearly two years.

          • 0 avatar
            John

            Bark – a dealer can price a used car at whatever the dealer wants. There’s no law saying a dealer can’t price a 2012 Corolla at ten million $ – because that’s what the dealer “needs” to make a profit – and the dealer can keep that Corolla priced at ten million $ for a while – but eventually, that business model will either change, or the dealer will go bankrupt.

            Your article states that dealers are asking high prices for used cars – and not selling much of their used inventory. They figure that charging even higher prices will save them – I don’t see that ending well for the dealers. The value of used cars in dealer inventory goes down with time, not up.

          • 0 avatar
            Scoutdude

            HMM that is not what I’m seeing.

            “Last year marked a record-setting year for the used vehicle market, according to Edmunds.com’s 2015 Used Vehicle Market Report. It showed that a total of 38,276,140 used cars were sold in 2015, a 5.6% increase over the prior-year period and the highest single-year total since 2007.

            Aside from rising unit sales, the report showed that the average price of each used car sold also went up. In 2015, the average used car sold for $18,600, an increase of 4.6% over 2014’s average used car price.”

            And according to this sales of used cars in Q2 2016 are up again over Q2 2015 levels.

            http://static.ed.edmunds-media.com/unversioned/img/car-news/data-center/2016/aug/used-car-report/used-car-report-q2.pdf

          • 0 avatar

            Don’t cherrypick. I said in comparison to new volume, which is rising at a much higher rate.

          • 0 avatar
            Scoutdude

            Seems like you are the cherry picker here.

          • 0 avatar
            Pch101

            Demand for used cars is absolutely not falling. Quite the contrary:

            http://static.ed.edmunds-media.com/unversioned/img/car-news/data-center/2016/aug/used-car-report/used-car-report-q2.pdf

            http://static.ed.edmunds-media.com/unversioned/img/industry-center/analysis/2015-used-market-report.pdf

            Prices have also climbed accordingly. There would seem to be a few reasons for this:

            -Demand is strong
            -The used inventory is getting newer, so it has depreciated less
            -The increase in CPO sales is outpacing the used car market as a whole — CPO buyers pay a premium that contributes to higher average prices

      • 0 avatar
        jacob_coulter

        Low interest rates and investors hungry for yield in a zero interest rate environment mean a lot more loans get written.
        Sub prime loans are at an all time high. Prices then go up as more people have the ability to pay.

        When interest rates move up, expect to see a big exit from investors willing to take that amount of risk.

        Eventually the bubble pops. And when it does, car dealers aren’t going to raise used car prices to make up for the shortfall unless they simply want to go to bankruptcy with a whole lot of unsold inventory.

  • avatar
    MrH42

    None of this makes any sense. When a used car doesn’t sell, dealers raise the price to protect their profitability? And their inventory doesn’t go up with this strategy? And now the car somehow magically sells, despite it not selling for a lower price earlier?

    You’re ignoring every basic macro economics principle in this article. You’re also ignoring reality. Go on CarGurus and track how the price of vehicles decreases the longer they sit until they eventually sell.

    • 0 avatar

      Awesome. Because car dealers are always smart businessmen with MBAs in Economics, right? Or did most of them just inherit dealerships? I forget which one is true.

      • 0 avatar
        MrH42

        So the entire country’s auto dealers are run by people who don’t understand Economics 101 and they’re all hemorrhaging money, because they inherited their businesses and are just stupid? Man, what an opportunity! Give me some capital, I’m about to become the Amazon of the car dealer world.

        • 0 avatar

          I’ve visited and consulted with thousands of them. But what do I know?

          And BTW, you’ve heard of Carvana, right?

          • 0 avatar
            MrH42

            What do you know? That’s a good question. Clearly not basic economics.

            The problem is your premise that used car demand is low is totally wrong. It’s just the opposite. When you accept that, everything else falls in line (why auction prices are high, why used car prices are high, etc). Instead, you get this original premise wrong, and the vast majority of your article now has to violate basic economics principles to fit your narrative.

        • 0 avatar
          28-Cars-Later

          Yes, that sounds about right.

          “I’m about to become the Amazon of the car dealer world”

          Tesla has issues moving things our of factory owned dealerships, good luck with an Amazon cars sales model.

      • 0 avatar
        jthorner

        The vast majority of new car dealerships are owned by national or regional multi-store big players, not by the third generation of inheritors. The inheritors almost all either sold out or got shut down in the troubles of 2008-2010. The one big family owned dealership I’m familiar with is in fact run by people with advanced degrees from universities and the NADA’s dealer education system.

        Your arguments don’t convey the broad knowledge of the industry you say you have.

    • 0 avatar
      carrya1911

      Basic economics is not terribly difficult to understand…any more so than basic arithmetic. Calculus is considerably harder even though it uses the principles of arithmetic, too.

      It’s when you have multiple factors, rational and irrational, in play among a bunch of different actors that basic economics ceases to be basic. This does not seem to be as simple as X (used car quantity) increasing with Y (used car demand) staying static. It also seems that folks are mistakenly using a binary definition of cars as new or used, when in reality there is a wide spectrum of “used” that is a significant part of the question here. There are a good many variables in play and it takes deep knowledge of the specifics of this segment to actually tease out what is happening.

      This is why successful financial firms usually employ analysts who specialize in a particular segment. Counter intuitive results abound in the real world and this sounds like another.

      It’s a fair bet that the dealers are not working a financial strategy for a decade. Likely their horizons are far, far nearer than that. I’d be surprised if they run on anything more than 18 months.

  • avatar
    turbo_awd

    I have a feeling one thing is getting left out here: people switch car models/styles/sizes all the time.

    That first-time car buyer who just got out of a 3-year Cruze lease may now be looking at a Malibu, Traverse or even Volt/Bolt, depending on job changes, family changes, etc. (I’m not an expert on all the GM vehicles, just using GM to avoid adding in complexity of Malibu vs Accord vs Camry vs …). So now there’s a strong demand for Malibus that wasn’t there, so the few off-lease ones sell for big $$$. Since this was a used sale, not just lease, 4-6 years later, buyer comes back wanting/needing an Impala/Tahoe. Another 5-7 years later, another one, then as empty-nest starts to hit, maybe a Camaro convertible or Vette?

    I’m in my mid-40s, bought a Legacy GT wagon almost 12 years ago. Started a family afterwards. 2nd car went from Mazda3 to minivan. I’m now looking for a sporty (track day?) replacement that can still carry 5 people in a pinch. One candidate is STI, since I’m already familiar with Subaru. Good luck finding ANY 2-3 year old STI with < 20k miles where they aren't asking within $2-4k of the price of a new one. Heck, some with 4-6k miles are basically asking the SAME as a brand new 2017 from Subaru, yet 2 years old.. So clearly, there aren't enough used STIs hitting the market, and prices are going up. This does agree with Bark's analysis.

    On the other hand, certain models are disappearing – Subaru no longer sells a turbo wagon in the US (I'd buy another one like my LGT). I don't need/want the monstrosity that is the '16 Outback with CVT. Would love the STI hatch to return – which is why I'm also looking at Focus ST/RS, hoping for a Mazdaspeed 3 return, etc.. Also put down a deposit on a Model 3 (gotta support local industry :-)

    Anyway, I think the one thing missing from this picture is:
    -demand for used cars is slowly trending upscale, as economy recovers and people are more certain about finances. Let's face it – no one WANTS a Spark/Cruze if you can easily afford Civic/Camry/Accord/etc.
    -as a result, there's probably a temporary glut of low-end off-lease cars, but those are often bought by the people that can't afford anything else/need a car. Those buyers are also often the least informed/have the least credit, and will often overpay some to just get a car. Often they don't have much choice.
    -as the demand for used cars shifts upmarket, there's a shortage at each tier, leading to increased sales at the same tier, since the same car new is probably almost the same price. This will lead to MORE off-lease cars in 2-3 years. However, a more upscale car doesn't always have the same "sweetheart" deals as a Cruze. And people don't mind paying a little more for a a nicer car if they can afford it. So the cars coming off-lease have a more realistic residual, and then there's not as much price inflation. STIs don't lease much, AFAICT, so I'll probably end up buying new if I go that route
    -at the extreme other end of the scale is the depreciation of luxury cars, where there's a huge discount for buying a 3-4 year old MB, for example.
    -the rich get richer (better value for high-end used cars) and the poor get poorer (overpay for low-end used cars)

    TL;DR – probably true at the very low-end of the car market, but probably less true at the higher end, which is probably more balanced

  • avatar
    Kenmore

    So much FUD just to wind up with someone else’s fart cushion.

    I just buy new, infrequently and frugally.

  • avatar
    Scoutdude

    Here is another little tidbit of actual data that shows that the banks are currently making bank on those lease residuals, and how they lost money in previous years. https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwiszqPurt3OAhVU_GMKHRAJBpkQFggnMAE&url=http%3A%2F%2Fwww.manheim.com%2Fcontent_pdfs%2Fproducts%2FUCMR-2016.pdf%3FWT.svl%3Dm_prod_consulting_latestupdates_graphic_2016&usg=AFQjCNEElE_nr1EOIl17dAHPJ1TtlT8Lqw

    So why are the banks able to sell their lease returns higher than the residuals?
    Because the dealers are willing to pay more than residual.

    Why are the dealers willing to pay more?
    Because they are able to sell for more.

    Why are they able to sell for more?
    Because people are willing to pay more.

  • avatar
    Kendahl

    Prospective used car customer comes into dealership. Salesman tells him, “I can sell you a new car for only a few dollars more than this used one.” Customer replies, “Great idea!” Scratch one used car sale. So, what happens to the overpriced used cars that nobody buys because they can get a better deal on a new one?

    This situation is a bit different than the real estate bubble. There were two problems with real estate loans. One was that people were being talked into loans they really couldn’t afford. The other was that “mark to market” failed to distinguish between loans that were in good shape and loans that were in trouble.

  • avatar
    deanst

    If the cost of the car in fact dictates the price, how do we ever have residual value losses? If dealers are selling fewer cars for higher profits, how do increased volumes of cars get sold? While bark’s argument may have some merit in the short term, in the longer term supply and demand work to dictate prices.

  • avatar
    Jeff Zekas

    The market doesn’t always flow according to the book. My son gave me an example: during the deepest part of the recession, when many contractors were struggling to find work, many RAISED their wage rates, because they needed to make more money off fewer customers. This was counter-intuitive, since less demand should equal lower wages. But that is exactly what happened.

    • 0 avatar
      Luke42

      Yes, because economics is about how real people act with respect to trade and resource allocation.

      The real world is under no obligation to follow Econ 101 principles, and it often doesn’t. This fact often makes people’s heads explode, especially people who base their worldview and politics on a simplistic understanding of supply & demand models. Those models are elegant but limited. ¯_(ツ)_/¯

      • 0 avatar
        carrya1911

        Basic economics works every time…but in the reality there are as many irrational factors in play as there are rational ones. And there are a wide spectrum of incentives and disincentives that pressure the supply and demand charts.

        In the example Jeff uses, there was likely a variety of quality among contractors. When everybody had more business than they could handle you get stuck with whatever contractor you can get. Then aggregate demand drops off and it’s likely the lower quality firms/contractors/agents were taken out first. Once there was too much business, now there are too many contractors.

        After an aggregate drop in demand survivors may have more business opportunities and more profit potential than ever. So the fate of individual players in the market is not necessarily a reflection of the aggregate. In fact, their fortunes can run polar opposite to the aggregate trend.

  • avatar
    HotPotato

    Seems like the screaming lease deals always assume a pretty fair bit of trade-in equity as a down payment. So the guy with a trade gets the sweet lease. The guy without a trade sees that for the same price as the new base model that he could reluctantly live with, he could instead get the loaded model that he really wants; yeah technically it’s used, but darned if it doesn’t still look and drive brand-new, and heck, that warranty’s better than on the new one.

    In other words…is it that CPO programs are propping up used prices? Because baked into that price is the cost of comprehensive reconditioning and a very good extended warranty?

    • 0 avatar
      Scoutdude

      Yes the increase in the number of cars sold as CPO has helped to increase the average price of a used car.

    • 0 avatar
      derekson

      Yes, CPO sales and pricing prop up residuals which reduces lease rates which increases new sales volume which increases the supply for CPO sales. It’s a self-reinforcing business model that works as long as you can find people to sign loans for the CPO prices.

  • avatar
    Jeff S

    Maybe part of the answer to keeping prices of used vehicles higher while demand eventually falls or levels off is to export the excess used vehicles. This would also keep the demand for new vehicles steady. There is only so much a manufacturer can cut production until it costs them more to produce less. Manufacturers want to make money on new vehicles and not used. Manufacturers still need to keep the inventory moving and will offer incentives to keep the dealers ordering new stock.

  • avatar
    manu06

    Lower interest rates and credit standards, lower gas prices, and an increase in the working age population
    has kept the car market moving. Eventually the bubble will pop, but bubbles tend to last
    longer than expected. When the delinquency rates start to rise the banks will pull back and pop this bubble.

  • avatar
    Budman

    Being in the market for another car for myself, I’ve been a regular checker of Cargurus.com for a year now and I’ve NEVER seen a used car rise in price! That is absurd and would like to see one example. Especially cars that have sat for long. The price history is right there in the profile of each car listed.

    Also, it depends widely the vehicle for which the price for used compares to same vehicle as new. I widely see out-of-favor vehicles selling for good bargains as used as depreciation with them has hit hard. Maybe some special enthusiast cars like the FR-S/WRX types, the ‘Camcord’ bunch and then the luxury stalwarts (BMW, Benz, Lexus, etc) are not much cheaper used than new. Your Fiesta ST is also among that group.

    Things like the 200/Dart are way cheap right now. Buick Verano is another I can think of. A lot of others too actually if you stay away from above mentioned group. Last year, right before the new revamped model came out, the Chevy Volt was an almost once in lifetime USED car bargain opportunity because of new model and the Fed tax credit others used to buy them new. I was seeing PREMIUM models with less than 20k miles on them for under $19k. To which they would usually get snapped up within a week. I wish I didn’t want something a little bigger because I’d surely have a very nice Volt that once sold for close to $40k for over half off.

    And this used out-of-flavor bargain “secret” has definitely started to get out more to car shoppers and is driving UP used car demand. In fact I just saw a 200 V6 with only 9k miles on it YESTERDAY on Cargurus for $18,599 to which it was no longer available this afternoon when I emailed them. In the past few months I have had almost similar (I hesitated 3 or 4 days) happen to me two other times.

    Sure there are also many cases where one could LEASE new for cheaper monthly than new, but I really think people are wising up (or got burnt once with that good-sounding deal already) and now realizing for a little more $$ I can own the car when done paying for it if we just buy used.

    So if anything, NEW car PURCHASES are the ones suffering in favor of, in order,
    1)leasing and low monthly $ for the shiny new smell as well as zero worries about repairs for next three years. In many cases even oil changes are included now. Some can even get away without buying tires or brakes in that time too.
    2)Used car purchase. Some factory warranty left and places like Carmax (place has been packed the two times I was in there) offering extended for good price. Used car reconditioning has really come a long way too and many times a few year old car paint looks new. This has the wow-effect for used car shoppers as they see “new” for cheaper. My neighbor bought a 2006 BMW 7 series with 90k miles on it for $15k and the paint looks seriously outstanding. You would not know it is a 10 year old car they drive to anyone but diehard BMW enthusiasts. You can “live the life” buying used luxury (until that major repair hits) and that has taken off as you see it often, increasing demand again.

    • 0 avatar

      I have access to 20k customer inventories that I review nearly daily. Dealers raise prices all the time on individual units, but what happens even more often is that they price their entire inventory higher on arrival when sales are slow.

      Your mistake is in thinking that all dealers want to sell cars as quickly as possible. That just isn’t so.

  • avatar
    olddavid

    Barkenomics 92. I would like to be a fly on the wall when you go on your rounds. I am certain we would leave the store with 180 degree different conclusions. However, I am willing to admit a bias of knowledge that goes to my experience. You have just come to a conclusion I believe cannot be backed by facts. The dealer who is 25% down on the 20th of the month who attempts to hold out for gross is a fool. 8% of a small gross is better than 50% of nothing.

  • avatar
    Chocolatedeath

    So this is why my wifes coworker cant find a CX3 that he wants. I looked for him and being used is only about a grand or so less than new.

  • avatar
    Ken Elias

    The analysis by the author is incorrect. Used car prices (wholesale) are set in a market comprised of many buyers and sellers. Used car prices will fall and precipitously once the consumer financing spigot gets slowed down. Used car buyers generally aren’t lease customers…mostly due to credit issues. They can’t get a lease rate if they’re not so strong on the credit. But in today’s world, I saw a “ghost” get a 9% rate on $20,000 loan with no stips. That’s the real story whey the used car market remains elevated in pricing.

  • avatar
    HiFlite999

    Not yet mentioned, but also a factor, is that the employment and wage picture is (slowly) improving. For example, in Michigan, the number of people working in manufacturing is back to where is was in 2007. Over roughly the same period, the percentage owning homes has declined. Both free up cash (or credit). Drive a clunker/save or buy a house gets replaced with renting, but drive something nicer. Since “the Jones\'” also rent, Range Rover trumps Equinox, pushing up average transaction prices even further.

    • 0 avatar
      wolfinator

      I suspect your view is warped by your local area. Parts of Michigan have a long-standing housing glut.

      In most of the country, the places with any improvement in employment or wages have housing prices back around pre-recession levels.

      And where I live, you ain’t saving money by renting. Quite the opposite – renters are completely screwed, but people who bought over the last 8 years locked in substantial savings over current renters.

  • avatar
    Mathias

    >> So because lease returns have high residuals, they actually cause used car prices to go up.

    No they don’t.
    Used-car managers bidding high is the ONLY thing makes used-car prices go up. Whether they sell or pile up is up to the banks, but the selling price got nothing to do with residuals.

    My 2016 low-end Cruze is gonna be worth $10k MAYBE at the acution at 24 months, 20k miles. I think it’ll be less.
    And the residual is nearly $12.

    • 0 avatar
      Scoutdude

      And the data I’ve seen is that the banks are doing quite fine and making profit at the auction on average. So yeah it is the dealers who are bidding many of the vehicles over the residual value. It does depend on the segment. They are dong quite well on gas guzzlers and taking a hit on fuel efficient vehicles like EVs, Hybrids, compact and sub compact.

  • avatar
    Higheriq

    Bottom-line: dealers will probably be able to buy used cars cheaper, but they sure as hell won’t SELL them any cheaper.

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