Supply, Lease-Returns, and Interest Rates Driving Near-Term Vehicle Market

Get used to settling for a “half-a-normal” market in the used and wholesale vehicles sector as a unique mix of macro- and micro-economic variables play out in the post-pandemic economic environment.

Key takeaways from the “Annual Remarketing Industry Outlook” session on March 27 at the Conference of Automotive Remarketing point to market factors not always working together like before to yield ideal buying and selling conditions.

The session, moderated by CAR emcee Charlie Vogelheim, included: Tom Kontos, chief economist at ADESA Auctions U.S., John Coles, senior director of data science and analytics at ACV Auctions, Jeremy Robb, senior director of economic and industry insights at Cox Automotive, and Dr. Alex Yurchenko, senior VP, and chief data science officer at Black Book and MOTOR.

The four experts each presented their latest data perspectives before moving into a roundtable discussion.

Higher Vehicle Prices Easing but Here for a While

Starting with macro indicators, Kontos made the following points:

The biggest inflation indicator is the consumer price index. “We know there's been a slowdown, but we all feel the impact of the cumulative impact of several rounds of months where the inflation was at elevated levels.”

Car prices are 30% higher than they were pre pandemic, Kontos said. “Just because the rate of inflation may have slowed down doesn't take away from the fact that prices have seen a pretty dramatic rise over these last few years. And we're still dealing with the higher prices for goods and services.”

At an overall inflation rate of 3.2%, “no matter how you really slice it, the Fed isn't where it wants to be. There's still some downside to the rate the Fed would like to achieve, while maintaining a soft landing,” he added, referring to a steady job market, consumer spending, and GDP growth.

Used cars show signs of disinflation, with wholesale prices dropping in the second half of 2023 that had started falling in May 2022, Kontos said. That has contributed to a lower rate of price inflation in 2023, compared to 2022.  

“The softening prices have probably opened up the market to a broader range of consumers and created a better affordability picture for consumers who are looking at the prices of new cars and getting sticker shock,” Kontos said.

During the pandemic period, used car prices rose more steeply than new vehicle prices. Now, used car prices are rising at a similar clip.

“If you look at the last 30-plus years, the used car CPI tends to run in lockstep with the new car CPI other than during this period of time, when it was very difficult to find a new vehicle because of the chip shortage,” Kontos said.

More Electric Vehicle Realities

Hybrid vehicles are getting more attention now because the bloom is off the EV rose given the negative media reports, Kontos said.

“At least there's maybe a more balanced view towards the potential demand for EVs. And the hybrid has become kind of a sexy alternative right now.” That could add up to higher wholesale prices for hybrids compared to other vehicle categories.

The Forces Driving the Market Now and Ahead

In his presentation, Coles posed the overriding question: What are the forces driving the market up and down today, as we go through the next couple months and through this year and next year?

“The reality is the used car ‘cabbage’ that people bought over the last three years is starting to rot a little bit,” Coles said. “When we look at what's happening in the new and used segment, the new vehicle segment prices are dropping materially.”

Coles outlined how vehicle inventories in the retail, rental, repo,   and fleet categories are turning faster now than in the last two years, with the increase in real-time listings as a key sign.

Higher interest rates are causing monthly payments to rise, prompting OEMs to add more incentives to make vehicles more affordable this year and into 2025. New vehicle production has started to ramp up across vehicle categories in the past year.

“But we're not seeing a comparable significant increase in demand for those new vehicles at the previous price point,” Coles said. “OEMs are stepping in and adding incentives to drive down new vehicle prices.”

Used vehicles are retaining higher values because six million fewer than normal came into the market between 2020 to 2023 given the shortage of new vehicles in retail.  “What you're seeing is consumers who purchased vehicles either used or new prior to 2020 have a significant amount of equity remaining in those cars,” Coles said.

Sometimes, “we focus so much on the short- to mid-term lens, that we miss the massive amounts of equity still locked up in any new or used vehicle bought before 2020.”

As of March, the Fed has penciled in three rate cuts for 2024, which keeps consumers in older vehicles, since they don’t want to flip to a higher-interest rate payment, Coles said. [With higher inflation numbers since March, the Fed appears to be holding steady].

Breaking Down Vehicle Markets by Type

When looking at how real-time vehicle markets are performing so far in 2024, different trends emerge in used vehicle prices based on body and power types, Coles pointed out. Electric vehicle prices have declined substantially since the start of the year, which means new and used prices will get more downward pressure than the broader vehicle market.

Hybrid prices could rise or fall based on how well they retain value as more plug-in hybrids enter the market, Coles said. The key question is: Will the consumer mindset lump hybrids into the general EV category or see them as an affordable, smaller vehicle?

Luxury vehicle values were rising hard toward the end of 2023, while smaller vehicles are retaining value at higher rates. Meanwhile, older used vehicle availability continues to be constrained, while 1- to 3-year-old vehicles are seeing meaningful negative equity.

“That’s a dynamic that we'll be navigating over the next two years, as used prices are coming back and following more normal depreciation curves, and new vehicles are fighting to maintain affordability.”

What Is Normal for Near-Term Used Vehicle Markets?

Using figures from Live Market View supplied by vAuto, a brand under the Cox Automotive umbrella, Robb offered the following insights:

In the first few months of this year, retail vehicle sales have been running strong, up about 6% versus the same period in 2023, but slightly down from 2022 and still 21% down from 2019.

“A lot of us talk about what is normal, but we don’t know exactly what normal is right now,” Robb said. “But we refer to pre-pandemic times in trying to find trends and anchor off that. There's just not a lot or as much used vehicle supply in the ecosystem now than there was before the pandemic.”

The slowdown in new vehicle volume sales production and the supply chain constraints in the U.S. automotive industry had a big impact, Robb said. “It’s hard for us to sell as many vehicles in used retail as we have in years past.”

Robb cited tax refunds as a primary driver of vehicle sales during the first and second quarters since many consumers use them as down payments. This year, the number of tax refunds are slightly down compared to last year, but still average $3,100 per refunded taxpayer, up about $180 compared to the 2023 average. Used retail prices are down about 4% YOY, but that’s offset by higher interest rates.

“Everything that can move the needle on affordability is important and helps out the marketplace,” Robb said.

Got CALE? Cox Automotive Lease Equity

In the segment of automotive lease equity, which Cox measures across most brands, Robb pointed out that most leases run 36 months. The Cox analysis looks every week at the value of lease buyouts at maturity at residual value. Then that amount is measured against wholesale MMR, producing a difference that is considered the lease equity.

A normal long-term average industry amount has been negative $1,000 to $1,500 based on pre-pandemic timeframes.

When 2018 model year leases came due in 2021, the industry saw a high increase in vehicle values on the used car side, with lease equity rising almost every week that calendar year, ending at a $10,000 positive average for that year. For 2019 MY vehicles, the 2022 average lease equity fell to $5,500 positive. Then for 2020 MY vehicles, last year’s lease equity average was about $5,200.

In 2024, lease equity is trending up because values are rising and higher residuals were set three years ago averaging about $2,600 for the industry overall,” Robb said. Because some models are getting closer to the break-even point or turning negative, they are more likely to be handled through auctions, Robb said.

Robb cited a 94% correlation between Cox’s automotive lease equity changes and which vehicles are coming into auction lanes.

“When automotive lease equity goes down, we just know they will come in, and that's why we're seeing about 80% more lease check-ins into auction right now versus this time last year,” Robb said.

But the lease equity market is still down at 70% of where it was in 2019.

A related factor to leasing is vehicle production, which took a hit in 2020-22 because of pandemic-related disruptions. As a result, OEMs did not have to offer as many incentives as before, which impacts leasing.

With leasing being expensive on the new car side, Robb said, OEMs didn’t offer incentives, which reduced lease penetration in the overall automotive market. Those leases will start maturing in July of this year.

“It takes three years to see the impact of the lease maturities, and that’s when we will see the impact of lower new vehicle sales and production and lower leasing that started, and it's not going to get better for a while,” Robb said.

Robb predicts an 11% reduction in overall lease maturities compared to 2023, and then another 22% reduction in 2025.

“A lot of the supply that three-year-old cars provide in the used vehicle ecosystem is very important for a lot of sellers, retailers, and the industry overall,” Robb said. “That supply is going to dry up a bit. Now we know values have come down on new vehicles. Inventory is a lot higher, and incentives are higher, too. All of that has a play in what's going to happen overall. But we do know and can easily measure at this point, that lease maturities will start to decline.”

Depreciation Points to the Long Market View

Yurchenko focused on the longer view provided by general annual vehicle depreciation trends since pandemic-era highs, which has accelerated in the second half of 2023 and will cause prices to decline further this year.

But that means a return to some normal depreciation. “One caveat is when we talk at the beginning of every year, we believe we are going back to some kind of normality and then something changes,” Yurchencko said.

In looking at weekly price changes, Q1 appeared to be going back to normal. Yurchenko looks at depreciation and retention based on vehicle age categories, or “buckets.” Across them, the vehicle segments did not see pre-2020 depreciation levels for the last four years.

EV Prices in Widespread Freefall

Based on the average retention by power train, the last two years were not good for EVs, when compared to hybrids and plug-in hybrids. Price cuts on new EVs led by Tesla immediately affected wholesale and retail used vehicle prices.

“When the overall market depreciated about 21% last year, EVs as a group depreciated about 30%,” Yurchenko said.  “We see very large depreciation across all EVs, both luxury and more affordable EVs like Chevrolet Bolts. We expect this to continue.”

With rolling EV prices cuts, the volatility for EVs will remain.

Hybrids, however, had a good run since 2020 driven by a lack of supply related to demand. “If you wanted to buy a Toyota RAV4 hybrid last year, you probably had to wait four months to get it. Now the inventory is improving. And we saw some corrections in the hybrid market. We expect the prices for hybrids to get back to normal, compared to the rest of the market.”

OEMs are increasing production of hybrids, and Toyota is going almost all-hybrid with the popular Camry model designated as hybrid-only. The path to vehicle profitability and demand is through hybrids, as the market for them expands, he said.

Yurchenko underscored that used vehicle prices will remain elevated for the next several years. 2025 will bring the lowest number of lease returns back to the market. Between 2021 and 2022, the number of leases were cut in half due to market shifts.

While the number of lease returns are set to decline, Yurchenko predicted the number of lease units returning to auctions will increase during the next one-plus years. During the last two years, more than 90+% of all leases were not returned to dealers or auctions because consumers either bought or kept them.

“They had a lot of equity in the vehicles so they kept them, so captive finance companies just didn't see those vehicles. Now we've seen increases in leased vehicle returns going back to the auctions while the overall volume of lease returns will decline in the next several years.”

Yurchenko further explained that as the number of lease maturities will decline 2025, the number of leased vehicles returning to dealers will increase. In 2020-23, as consumers kept 90%+ of their vehicles, most did not make it to the auctions. The rest was mostly kept by dealers because they needed inventory. Starting this year, consumers are returning more vehicles to the grounding dealers, and that in turn, will increase the volume going through the auctions.

On price retention, Yurchenko pointed out how pandemic-era vehicle prices saw retention peaked by 72% due to constrained supply, but despite recent declines, retention is still 31% above 2019 levels.

“Baseline, we expect the prices to decline, but in the next two years, we expect prices in the used wholesale vehicle market to stay above 2018-19 levels by at least 20%,” Yurchenko said. “But if you take the much longer view, prices will still be much higher than we've seen historically.”

Follow-On Market Indicators

In a roundabout audience Q&A led by moderator Charlie Vogelheim, the panelists shared the following insights in response to questions:

• While the inflation rate inflation has been declining in the past year, it started to tick up again in Q1, driven by housing and rents. Fuel prices also increased in Q1. As in the housing market, there is a logjam of many vehicle owners and buyers on the sidelines ready to move or trade based on interest rates which are at the mercy of the Federal Reserve interpreting inflation signals.
• Consumer confidence grew in the past year as inflation rates cooled, and how those two variables play out determines the demand market for vehicles.
• Consumers are trying to buy more affordable vehicles, with some who couldn’t afford peak-price new vehicles able to buy slightly less expensive new ones now on the market or used ones. Those buyers who couldn’t afford higher-priced used vehicles are finding better deals. Across both the wholesale and retail vehicle markets, the strength shows in more affordable vehicle categories and models.
• In an atmosphere of high interest rates, vehicle buyers will look closely at the monthly payment to determine affordability.
• Consumers’ savings this year are declining at a faster rate as they drain down pandemic era savings and government relief programs have ended. That affects the consumer psyche when encountering higher interest rates. Bottom line: Less money in checking and savings accounts and inflation make consumers less likely to take out loans at higher-level interest rates.
• U.S. new vehicle sales likely will stay under 16 million this year compared to more typical past averages of 17 million+ new vehicles sold.
• Before the pandemic, about 20% of used vehicles on dealer lots sold for above $30,000. Now it’s still more than 40%.
• Vehicle incentives averaged about 10-11% of MSRP in 2018 and hit a pandemic low of 2% in 2022. Now they are at about 6.5% of MSRP. Much of that can be attributed to $4,000 federal tax credit toward a used EV and a $7,500 credit toward qualifying new models.
• During the pandemic, OEMs focused more on high margin, fully loaded new vehicles in their limited production, but now more vehicle models with fewer options and lower prices are returning to the market and helping increase availability and affordability.
• Look for pricing and value disparities among used EVs, hybrids, and diesel vehicles in the coming months and years as used inventory bought new during pandemic-era peaks flow into the used market. These segments should be tracked independently.
• If gas prices spike again, EVs and hybrids will gain demand along with smaller, more efficient ICE vehicles. But for buyers, the question remains if it makes sense for their lifestyles.
• Leasing programs lend themselves better to EVs because it eases the uncertainty consumers deal with about buying an EV. They can try it out on a short-term or 36-month lease. Banks and captives should create financing programs with attractive lease payments that can boost market share while encouraging consumer support for EVs. That works better than a government mandate.
• For wider consumer acceptance of EVs, prices need to decline, even though that’s not good for fleets that already bought new EVs. EV prices will likely drop further as global OEMs compete on market share and smaller manufacturer players drop out of the market.
• Three years from now, residual values and vehicle retention will still be above pre-pandemic levels as wholesale vehicle volumes decline in the next few years.
• There will still be a lower supply floor under the vehicle market that will keep prices from dropping too far.