August 1, 2021

Off-lease appreciation a tool for dealerships

Off-lease vehicle returns can be a blessing as dealerships scramble to supply used-vehicle departments amid the microchip-induced inventory shortage. Some dealerships are working hard to entice lease customers to return their vehicles even with a dearth of new-car inventory from which to choose. But they report satisfied customers and consistent profits from the return of off-lease vehicles.

Still, customers hoping to profit from the valuation boost are struggling with auto lender practices that make benefiting from lease value increases a challenge.

Robert Tabet, director of finance for Suburban Collection in southeast Michigan, said few lease customers returning to market are looking to take advantage of their vehicle’s appreciation by buying it themselves and then selling it. For those who are, however, he notes certain lenders are easier to work with than others. But there are also challenges when the dealership works with the lender — which can slow the process of how dealerships acquire much-needed inventory.

“The second that the lender requires us to pay market value, then there’s a good chance that we’re going to pass on it,” Tabet said.

For example, Ford Motor Credit Co. stipulates that if a lease is within 120 days of termination, dealers are required to pay the market price, which may or may not be higher than the vehicle’s lease-end value. Chrysler Capital says a vehicle within 30 days of lease maturity won’t qualify for a lower buyout price. If a dealership wants that vehicle, it has to work to acquire it ahead of those deadlines, Tabet said.

Roughly 70 percent of all new and used sales at Suburban are leases, thanks to the high population who qualify automaker employee incentives in Michigan.

Some automaker captives allow dealerships to purchase off-lease inventory on the lower end of market value or the residual value, depending on the dealer’s relationship with the automaker, said George Athan III, senior vice president of operations at Holman Automotive. Other auto lenders require dealerships to pay market value for off-lease vehicles.

“This has become a very, very profitable proposition for the OEMs, whether they’re selling to dealers or they’re running those cars through auction,” he said.

Dealerships are grounding off-lease vehicles — purchasing them to sell to other customers — at an unprecedented level to offset scarcity in used-vehicle inventory. Cox Automotive estimates half a million vehicles were grounded at dealerships rather than entering auction lanes. Another half million will likely be similarly impacted this year.

In Michigan, Suburban’s 34 dealerships are grounding off-lease vehicles regardless of the brand or age to assist their new parent company, Lithia Motors Inc.

Steve Lind, vice president of operations and advertising for Kelley Blue Book, said the dynamic is creating an interesting opportunity for consumers to negotiate at the dealership.

“A lot of people are in equity in their lease trade-ins, which is going to put a lot of pressure on available inventory if those aren’t coming back to the dealers,” Lind said. “It’s a good opportunity to take care of a customer, keep them in your dealership, keep them in your brand in a sort of a new dynamic.”

Proactive dealers, according to Tabet, “are the ones certainly capitalizing” on conditions in high-leasing markets such as Michigan and New Jersey.

For Athan, that means reaching out months ahead of when his stores would typically approach customers about their next vehicle. Even so, customers are beating sales employees to the punch, coming in six months or more before their lease termination date.

“The good news for consumers is they’re able to take that equity and then roll it into another car,” Athan said. “The challenge is if they can find another car that suits their needs.”

Some of the group’s Toyota and Lexus stores are down to less than 10-day supplies, Athan said. One Holman Cadillac store had even less.

In addition to poor selection, customers are contending with higher prices. Automakers are less willing to subvent leasing rates, Athan said, and customers exchanging those vehicles are struggling to find a monthly payment comparable to what they had.

In the short term, dealerships can manage off-lease appreciation in a way that satisfies customers and allows them to take in the inventory, according to Mike Campo, director of finance and insurance at Mercedes-Benz of West Chester in Ohio. But he believes automakers are being cautious about pricing, concerned that once the shortage comes to an end, those values will decline rapidly.

“We’re going to pay for this in some way,” he said.

Because of that, lenders may be offering to buy out leases at much lower prices than what industry tools would suggest those vehicles are worth.

If a customer wants to purchase the off-lease vehicle and sell it themselves for the higher value, the process can be somewhat arduous with certain lenders, Tabet said.

It’s “probably more than what the average customer wants to endure — time- and collateral-wise,” he said. “But at the end of the day, is it worth it? Probably.”

Still, it makes sense for lenders to be more cautious about paying higher prices for off-lease vehicles. Moderating demand could also drag down vehicle values. Dale Pollak, executive vice president at Cox Automotive and creator of the vAuto inventory management software, warns dealerships about loading up on used inventory without caution.

“I’m not saying that dealers shouldn’t keep their lots stocked; they should,” he said. “But they should do it with moderation and discipline.”

The appreciation swing has been a tool for Campo’s dealership employees to demonstrate the benefits of leasing. Approximately half of the dealership’s 60 new vehicles sold per month are leases, Campo said.

“We can still come out ahead, even paying for disposition and reconditioning, than if we had to buy it back from the manufacturer,” Campo said. “Buying it from them [customers] is exponentially easier, and we make them happy.”

Automakers haven’t scaled residual value estimates for newly originated leases, Athan said, a decision he thinks could rest on the hypothesis that pricing will descend back to normal levels once those vehicles return to market in two or three years. But for now, the manufacturers could spread the love, he said.

“The manufacturers are in an extremely favorable position, and that can be a challenge for dealerships and consumers alike,” he said. “Assistance in the form of pricing discounts, market value corrections or adjustments to residual values would really help the entire industry navigate the ongoing supply constraints.”

David Muller contributed to this report.