The Used Car Pile-Up

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

2017 is shaping up to be an excellent year to purchase a used car. That's fine news for consumers — but a big worry for auto manufacturers, rental companies and auto finance groups.

Extra vehicles coming off lease

This chart explains why:

Thanks in part to low interest rates, leasing has become an increasingly popular way to drive away a fresh car. It accounts for almost a third of all fresh car transactions in the U.S. and it's also enormous in the U.K., as I explained here. For BMW and Mercedes-Benz in particular, it's been a boon for sales.

Typically a lease lasts about three years, after which the customer comes back to the showroom for another vehicle — which is when things could get difficult for the industry.

“There's going to be a lot of units coming back over the next several years,” Ford Motor Co. warned last month. “They're going to get to levels that we have never seen on an absolute basis in the industry before”.

In 2017,  about one million more off-lease vehicles will be available in the U.S. compared with 2015. That extra volume will put downward pressure on used car prices.  

If cars depreciate too quickly, consumers will be unwilling to pay high prices for fresh vehicles. High residual values also help to keep monthly lease payments low. In other words, if used car prices fall, the entire system comes unstuck: automakers' earnings will likely fall and car finance companies (often a subsidiary of the manufacturer) may have to book writedowns on the value of their leased assets.   

During the two thousand eight recession fewer people bought fresh cars, meaning there weren't so many used cars for sale in subsequent years. That's helped price to hold up fairly well, but there are signs that's all about to switch.

Last month, Hertz Global Holdings Inc. warned of a big increase in depreciation rates for its rental fleet due to lower than expected resale values. It warned residual value pressures would proceed into next year and that others in the industry “can't be immune to this factor.” Its shares plunged.

Industry-wide used car prices are falling most for compact and mid-sized cars, reflecting U.S. consumers' enlargening preference for SUVs and trucks. 

Investors aren't oblivious to the risks. Albeit Donald Trump's election caused auto stocks to rally  – due to a possible entertainment of costly fuel economy regulations and tax cuts that might spur auto purchases — it's uncommon to find an automaker that trades on more than eight times estimated earnings (Fiat Chrysler fetches just five times). 

There's one big consolation, tho’: nearly-new vehicles should be going cheap next year.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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