Why there is a bounty of used cars

Not everyone is happy about the surplus of used cars in the US market. Just look to Detroit. 

Dan Reel shows one of his off-lease vehicles on the lot at Reel's Auto, a used car dealership in Orwell, Ohio, April 26, 2017.

Three years ago if a customer walked onto Dan Reel's used car lot seeking a late-model off-lease Ford Escape, his answer was short: tough luck.

The supply of lightly-used cars and trucks was tight because automakers had drastically cut back on bargain leases during and after the Great Recession.

Recently, though, a computer search for available used vehicles within 150 miles of Reel revealed an eye-popping figure: 668 Escapes. That's enough to put more than 40 percent of the inhabitants of this small northeastern Ohio town, population 1,600, into the popular crossover.

A search for the Chevrolet Equinox, a comparable crossover, showed 461 available.

"The automakers have flooded the market," said Mr. Reel, owner of Reel’s Auto in Orwell, Ohio, about 40 miles east of Cleveland.

That deluge is good news for used-car dealers, auto auction houses and car buyers, who stand to benefit from a bountiful supply of high quality, off-lease vehicles rolling into the US market.

By the end of 2019, an estimated 12 million low-mileage vehicles are coming off leases inked during a 2014-2016 spurt in new auto sales, according to estimates by Atlanta-based auto auction firm Manheim and Reuters.

That's helping independent dealers such as Reel, who can turn a quick profit on vehicles bought cheaply from auction companies.

Big players like AutoNation also aim to benefit from selling late-model vehicles at a discount versus brand new cars.

Chief executive Mike Jackson said rising off-lease car numbers means "a higher supply of pre-owned vehicles at a more attractive price.”

Consumers seeking great deals are in luck. Used-vehicle prices at auction fell about 3 percent last year, according to Carmel, Indiana-based KAR Auction Services Inc., which facilitated the sale of 5.1 million used and salvaged vehicles in 2016. Used prices should drop around 3 percent annually for the next couple of years, according to KAR's chief economist Tom Kontos.

General Motors Co. and Ford Motor Co. say prices for its used vehicles, which consist largely of nearly-new ones coming off lease to consumers, fell 7 percent in the first quarter versus the same period in 2016. GM says it expects a 7 percent decline for 2017 compared to last year.

Detroit three not celebrating

While many used-car dealers and their customers are spoiled for choice, the glut bodes ill for GM, Ford and Fiat Chrysler Automobiles NV and is one reason the Detroit Three's share prices are stuck in neutral.

Demand for new vehicles is slowing after seven consecutive years of rising sales. Meanwhile, carmakers' discounts on new vehicles have surpassed record levels set during the Great Recession. Those discounts have been averaging over 10 percent of a new vehicle's average selling price, according to industry consultants J.D. Power and LMC Automotive.

Slumping prices also hurt automakers' in-house lenders. They price leases using a car's "residual value" - an estimate of the vehicle's worth after its lease ends. If that value is lower than expected when the vehicle is resold, profits suffer.

That risk was highlighted last November when Ford lowered its financial service arm's pretax profit forecast by $300 million, citing falling resale values for off-lease vehicles.

Still, carmakers show no sign of abandoning leasing. In the first quarter, leases made up 31.06 percent of sales to consumers, just below the record set in the second quarter of 2016 of 31.44 percent, according to data from Experian.

Wall Street is worried carmakers are repeating past mistakes. Shares of GM and Ford barely budged last month after their earnings both beat analyst expectations. But when the companies reported disappointing April sales last week, GM's shares fell 3 percent and Ford's 4 percent.

Automakers contend there is little cause for alarm.

In late April, GM chief financial officer Chuck Stevens said off-lease vehicles were "an issue," but insisted that "overall the used-car market is absorbing that supply."

Others see it differently.

KAR CEO Jim Hallett said there's now an oversupply of off-lease vehicles.

"The flood of lease cars puts a lot of pressure on automakers and their dealers to get new cars sold," he said.

Cookie cutter vs. Unicorn

In a market teeming with product, attention is now on auction sites, a critical link in the used-car food chain. The US trade is dominated by Manheim and Adesa, a unit of KAR. These companies re-sell cars and trucks returned to automakers from rental car companies and consumer leases.

Franchise dealerships get first dibs on inventory. The leftovers are available to independent dealers through online and live auctions.

KAR's Hallett says the company makes money on the volume of cars sold, so rising supply boosts business. Manufacturers are also using more of KAR's ancillary repair and finishing services to make vehicles look as good as possible for sale, he said.

Supply is currently so swollen Adesa now offers used dealers a guarantee: they can return any car they buy online within 30 days if it doesn't sell and only end up $50 out of pocket.

Used-car dealers are also tweaking their strategies for a glutted market. Reel, the Ohio dealer, hunts for unique vehicles that can command a slight premium.

Joe Mok, general manager of Gmotorcars in Chicago, doesn’t care about unicorns. His strategy is to sell cheap. He recently bought 15 virtually identical 2015 Ford Fiestas for $6,900 and sold them for $7,600.

"What's going to make somebody come to my store if we all have the same color Toyota Camry with the same miles?" said Mr. Mok, who owns two dealerships. "They'll come to me because of the price."

With used-car prices falling, the pressure is on dealers to sell vehicles fast before they lose value.

Rather than keep too much inventory on his lot, Reel entices customers with the prospect of almost unlimited choice on the auction sites.

"I can get almost any off-lease car a customer wants within 48 hours," he said. "The only question is: 'What color do you want?'"

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