Estimating the value of a used car isn’t easy. So many factors have to be considered, including the original selling price, depreciation, the state of the used-vehicle market, mileage and the value of accessories as the car ages.
If determining today’s resale values is tough, what must it be like to predict what a car or truck will be worth five years from now? That’s the job of the mathematicians, statisticians and data analysts who turn out little books of updated “residual values” every couple of months.
Leading the list of publishers of residual values is Automotive Lease Guide, put out by a 30-member company of the same name in Santa Barbara, Calif. Every two months, ALG issues a booklet filled with percentages, which indicate the proportion of a vehicle’s original price that will remain when it’s 2, 3, 4 and 5 years old. Automakers and their “captive” finance companies, banks, credit unions and anyone involved in vehicle leasing consult these books. Separate books are issued for Canada.
Another edition of the book gives dollar figures instead of percentages, but the principle is the same. ALG predicts what a Toyota Camry or a Jeep Liberty that’s leased today can be sold for when the lease has run out. “Residual” means what’s left, measured in actual dollars or as a percentage, of the vehicle’s original cost when it reaches a specified age.
Automakers’ leasing departments have to be able to predict residuals to establish suitable monthly payments. When you lease a vehicle, you’re effectively financing the difference between the selling price (transaction price) of the car right now and the amount it will be worth later (its residual value). If a $25,000 sedan is estimated to be worth only $10,000 at the end of a three-year lease, the lessors will come up with down-payment and monthly-payment amounts to cover $15,000, the amount that will be lost in that period.
But if that same sedan is worth $15,000 after three years, the customer only has to pay $10,000 in the same period. So, monthly payments will be considerably lower. If residual values are low, the monthly payments are higher, which is why it generally costs more to lease a lower-priced car that’s known to lose its value fast, than a higher-priced model that retains its value.
New-car buyers also can benefit from knowledge of residual values. Pick a model that’s known to have strong residuals, and you can expect to sell it eventually for a good price. One with weak residuals won’t be worth much secondhand.
To come up with these percentages, ALG begins with current valuations. They add wholesale auction data, industry knowledge and near-future assumptions.
“It’s predicated on how the used-car values are performing right now,” said ALG managing editor R. Robb Cerruti. “That’s a starting point.”
The ALG “economic team” considers such factors as the used-car Consumer Price Index, issued periodically by the federal government’s Bureau of Labor Statistics.
They also look at the number of vehicles that are coming “off-lease” and the overall vehicle supply expected in the months and years ahead. Cerruti foresees a large supply of off-lease vehicles entering the used-car market in 2002, many of which are 1998 models.
New-car pricing also plays a notable role in predicting residuals.
Though prices have edged up recently, they are down or flat on an equipment-adjusted basis. When automakers issue the new season’s models, they often raise prices, but include more standard equipment.
No less crucial are new-car incentives, because they affect the number of vehicles that are sold or leased, as well as the total prices paid for them. Incentives include cash rebates and low-interest financing.
National and global economic issues, such as the dollar-yen relationship, also make a difference on a more subtle level.
“We’ve seen a bit of stabilization” lately, Cerruti said, with mainly the usual “seasonal drops.”
Guide dropped values
Early in 2001, though, Automotive Lease Guide caused quite a stir when its residual values dropped. For the January-February issue, ALG slashed 36-month values by an average of 3.7 percentage points. Values of full-size and compact sport-utility vehicles sank as much as 6.8 percent. The average 3-year-old vehicle, considered to be worth 50.5 percent of its original value, was declared to be worth 46.8 percent.
Manufacturers and lenders saw billions of dollars of theoretical vehicle value.
“There was a pretty good correction in our values” at that time, Cerruti said.
In November 2000, analysts began running the numbers, noting that new cars for the 2001 model year were being launched with incentives.
In the past, rebates and other incentives had been used mainly to trigger sales of slow-moving models. Now, incentives were tempting customers when the vehicles were brand-new, which to ALG helped create an artificial demand.
In addition, it was widely known in the industry that for several years, automakers had been engaged in excessive “subvention” of leases.
To keep monthly lease payments as low as possible, manufacturers offered unrealistic leasing deals, inflating estimates of what the vehicles would be worth when they came off-lease and had to be resold as used cars. To move the merchandise, the automakers elected to absorb any potential loss if resale values turned out to be lower than hoped for.
It was becoming obvious that residual valuations needed to more accurately reflect what a used-car dealer could expect to get for a particular vehicle later on. Instead of a gradual reduction, ALG made the needed corrections in one move.
The abrupt decline in sport-utility valuations was necessary, Cerruti said. Going back to 1997, “some of our numbers were wrong.” Oversupply played a role, when manufacturers introduced a new model and built too many to sell easily.
Books and online services that list current used-car resale values are common, but residual estimates are a little harder to find. Several other publishers issue residual figures, including the Black Book, widely known in the used-car business for estimates of current vehicle values.
ALG is the book most used by automakers, banks and auctions, however.
ALG was formed in 1964 by Jim Aiken, a pioneer in the leasing business. His son, Doug, is publisher, but everyday activities are controlled by a group of younger men.
Only 10 or 11 of the company’s employees are involved with numbers and calculation of values. Others deal with portfolio analysis and client data, because ALG prepares customized figures for other companies, as well as printing its own residual-value guidebooks.
Custom guides “use us as a baseline,” Cerruti said. One of them might choose to go a little higher or a little lower, often for competitive reasons. But they take ALG’s basic figures as a starting point.
Industry watches numbers
ALG gets its share of complaints and pressures. A manufacturer’s brand manager might complain about low residuals. Lenders and wholesale auctions complain if they’re deemed too high.
The “front end guys [who] want to sell them” have a different perspective, Cerruti said, than those who build the vehicles. “You can’t please everyone.”
So ALG’s theme is: “If everyone’s mad at us, we’re doing a pretty good job.”
DaimlerChrysler, for instance, took exception to ALG’s relatively low residual values for the PT Cruiser, which practically leaped out of showrooms–at well above sticker price–when introduced early in 2000.
“Success in year one doesn’t necessarily constitute success in years two and three,” Cerruti said. Sustainable access is the key. “We agreed to disagree on that vehicle.”
