The Expert Podcast

One of the reasons that the used car market has been thrown out of whack for the last couple of years has had to do with auto leasing. You might say, "Well, what does auto leasing have to do with the used car market?" Well, here’s what happens. When a new car dealer or even a used car dealer needs to get inventory for their car lot, there’s no used car factory. There’s not a company that makes used cars. If you're a new Ford dealer and you need new Fords, you call the factory and say, "Ship me a bunch of Ford F-150s, Mustangs, whatever." If you need used cars, there's no factory you can call to say, "Send me some used cars." Used cars don't grow on trees, so where do they come from?

Well, one source for a dealer is trade-ins. When somebody trades in their old car for a new car, now you have a used car you can use for your lot. Well, by definition, that means you’re going to get fewer used cars than you sell new cars. So if you’re a dealer and you sell 100 new cars a month, at the very most, you're going to get 100 used cars to sell. However, most of those people—well, not most, but some of those people—don’t trade in a car. They just buy a car without a trade-in. So now maybe you have only 50 trade-ins. Well, some of those trade-ins you don’t want to sell on your lot. There might be an old, beat-up car with high miles, or maybe a car that's nice or newer but doesn’t fit your inventory. If you're a Ford dealer and somebody trades in a Ferrari, you're not going to put it on your front line. Even if it’s something not quite that extreme, maybe you're a Ford dealer and somebody has a high-end Acura or a low-end Kia, you might not put it on your lot because it might not match your demographic. People might not be coming to your Ford dealer to buy a base model Kia. So, that might give you 20 or 30 trade-ins a month that you can sell on your lot.

Well, if you want to sell as many used cars as you do new cars, you need to fill that gap. If you get 20 nice trade-ins or 30 nice trade-ins, you now need 70 more cars per month to put on your lot. Where are you going to get them from? Well, these cars come from auctions. They come from auctions, and there are two main auctions. There’s Manheim, which is one of the largest auction companies, and they have auctions almost every day. The dealers can buy cars there. Where did the auctions get the cars from? Well, they come from two main sources. They come, number one, from rental cars. When Hertz, Enterprise, Avis, and Budget have a car that’s rented, and they buy them new after two years or three years or a certain number of miles, they bring them to the auction to sell. Dealers will be there buying up those cars. But the other big source is off-lease cars. It used to be that a large percentage of new car purchases were done using a lease. So when you lease a car for two years or three years, at the end of that lease, you bring in the keys, drop them off at the dealership, and you take off. Maybe you buy a new car. Either way, when you drop off that lease, the dealer doesn’t necessarily keep that car. They may have an option to, but those cars also go to auction. Either way, whether the dealer keeps it or goes to auction, that lease turn-in is now extra used car inventory.

Now, what’s happening is people are not leasing cars as much as they used to. Right? People are either financing, buying them in cash, or buying them through credit unions. Leasing isn’t as popular. We’ll talk about why in a minute, but the fact that these leased vehicles are not coming back into the marketplace is putting a big reduction on used cars. More importantly, they're the better quality used cars. Think about it. If you have two cars, one is an off-lease where somebody was the owner, they drove it every day, they took care of it, they had free maintenance. Right? Usually, lease cars come with free service for the first two or three years. And then right next to it, you have a rental car. Which one’s going to be in better condition? Right? That rental car, whoever drove it, there might have been a thousand drivers of that car over the course of three years. Every one of those drivers didn’t care about that car. They drove it for two or three days, and they just beat it up. They don’t really care that much about maintenance, they don’t care about how they drive it, driving it easily, going up on curbs, going over bumps. They’re not going to take care of it like an owner would. And the rent-a-car company—look, all they need to do is make it last for two or three years and then give it back to the auction. So, they’re going to do basic maintenance, but they’re not going to go out of their way to do synthetic oil, extra oil changes, and really good service. They’re just going to do the bare minimum because they don’t want to spend the money. They’re not really their cars, they’re going to get rid of it.

So, these lease cars were the better quality cars. They were the better inventory. Another thing about lease cars is that they were also better equipped. Meaning that think about when you rent a car. It’s usually a base model, doesn’t have any extra options, and the colors are more basic. A lot of rental cars are white or silver or gray. Where people, when they buy a car for their own use, they want to make sure it’s very customized. It’s a higher model, it might be the luxury model with a sunroof, and digital dash and everything else. Lease cars don’t have the XM radio, they don’t have a sunroof, they don’t have nicer wheels. They’re more basic cars. So, these off-lease cars were very, very good inventory for dealers to have because they were more customized personal cars. And that was a big deal when it came to resale.

So, now what does this mean for the used car market? Well, dealers or used car marketers now don’t have the same volume of inventory and the same quality of inventory. What that does is it pushes the prices up because normally, these off-rental cars, which were more basic, plain vanilla cars, sold for mediocre, average prices. Well, now those are the only game in town, so those are now selling for higher, more marked-up prices. The off-lease cars or the better quality cars, when they come in, those sell for all the money in the world because they’re very rare. Right? They’re instead of 30 or 40 percent of the cars, they’re now one out of ten. Right? They’re like a diamond in the rough. So, these off-lease cars are incredibly valuable.

What also made it more difficult is, in the past, it used to be when you got to the end of your lease, you would have what’s called a lease buyout. Right? You didn’t have to come in and drop off your keys. You could just buy out the rest of your lease. So, let’s say, for example, you had a lease buyout option of $20,000. Every lease has a fixed amount at the end of the lease that you can pay to keep your car. Well, if you decided to do that buyout option, you just paid that money and you kept your car. Well, in the past, that number was a lot higher than what the car was actually worth because leasing companies used to artificially inflate these buyout options in order to reduce the payments to make it more appealing to lease a car. Well, when the used car market went crazy in 2020 and 2021, a lot of these older leases had a buyout option of $20,000. Well, now the car might be worth $25,000 or $26,000. So, a lot of people who are at the end of their lease decided, “Wait a minute, I’m not just going to drop off my car, I want to keep it. This car is worth $25,000. I only have to pay $20,000. Boom, I’m writing a check,” and now they kept the car. This kept more vehicles out of the marketplace. And the fact that the car market is now more competitive for buyers, it’s a seller’s market, the leasing companies don’t have to be as aggressive with their lease deals anymore. They don’t have to offer as many incentivized leasing deals, so leasing is now going down in popularity.

Put all this together, what it means is fewer new cars are being leased, which means fewer quality, desirable used cars are hitting the market. This is something that affects used car buyers and even affects new car buyers because a lot of high-end, quality used cars displace new car sales. So, somebody might go into a dealership to buy a new car, and they say, “Wait a minute, here’s a two-year-old used car off-lease, 20,000 miles, I’ll buy that one instead and save some money.” Now, since that car doesn’t exist, you have to buy new if you want a very high-quality car because off-rental cars are not going to be good quality cars. This is really throwing the used car market even more into turmoil and making it tougher for dealers to get good inventory.