IE 11 is not supported. For an optimal experience visit our site on another browser.

Leases lose favor on the auto lot

As cars grow more affordable, the auto industry has quietly been weeding out one of consumers’ most popular options in the 1990s: leasing. Many in the industry wonder whether the auto lease’s days are numbered. MSNBC’s Jon Bonne reports.
/ Source:

The U.S. auto market has seen extraordinary strength in the past two years, even as the economy has stumbled to regain its footing. As cars grow more affordable, the auto industry has quietly been weeding out one of consumers’ most popular options in the 1990s: leasing. With ever more affordable cars being built and sold, many in the industry wonder whether the auto lease’s days are numbered.

The same factors that charged the industry’s cylinders after Sept. 11, prompting Americans to buy cars in nearly unprecedented numbers, also drove car companies to scale back leases.

Essentially, the low-finance options made it cheaper to buy than lease.

“Leasing’s been toast since 9/11,” says Christopher Struve, auto industry analyst at Fitch Ratings. “Actually, it was toasty before then.”

In the 1990s, leases were huge with consumers and the industry created a lease boom of sorts. But within the past two years, lower prices, rock-bottom finance rates and a steady stream of cash-back options has made outright purchasing more attractive. Dealers have often made it cheaper for a driver to buy a new car at the end of a lease than to purchase the one they’ve been driving.

For example, a GMC Yukon lease in mid-boom might have required a customer to pay hundreds of dollars a month and then fork over $25,000 to buy outright after three years, while the same customer might look across the lot and pick out a similar used model for $20,000 or so — or buy a new one and capture a low-rate loan.

Those lump-sum payments to buy vehicles at the end of their leases, known as residual values, have been a boondoggle for car companies. Residual values were already set high during the ’90s lease boom; heavy production since 2001 not only made cars more affordable but frequently drove down both new and used car prices, often below residual prices. Customers drove off in new models and left automakers with a glut of undervalued, used vehicles they had to resell. “It was a tremendous remarketing fleet two years ago and again last year,” says Anne-Marie Sylvester, spokeswoman for GMAC, General Motors’ financing arm.

No more 'roaring in'
The discrepancy would have been a problem no matter what, but low-rate financing and rebates lured thousands of customers into the showroom and turbocharged the effect. As such, the current leasing bust is in some ways a good thing for automakers.

Still, they are largely at fault for creating their own perfect storm in the lease market. Leasing can be risky because it relies so heavily on forecasts. Automakers and dealers must set residual prices when the lease is written and thus must predict car values two or three years down the road. The rapid move from the ’90s lease boom — what General Motors chief Rick Wagoner called “roaring in with leases” — to post-9/11 pricing put a serious squeeze on the industry.

“The companies have guessed wrong a lot on residual values,” says Burnham Securities analyst David Healy, who tracks the auto industry. “They shot themselves in the foot, sort of.”

It should come as no surprise, then, that dealers expect a low of 3.26 million leases this year, some 20 percent of the total auto market, even as overall sales hit some of their highest levels ever. Automakers, notably the Big Three, have scrambled to close out the remnants of the lease boom. Chrysler, for example, cut its leasing last quarter to 10.7 percent of retail sales, down from 16 percent a year ago. With many three-year leases signed in 2000 ending this year, they are slowly pulling themselves out of their conundrum — their finance divisions seeing profits on many leases dwindle down to almost nothing while they push the cars to auctions and secondary dealers.

The whole experience, some industry watchers feel, has left car makers feeling tender about the lease market. That has been capped by some overwhelming success in financing, which has left the finance divisions of GM and Ford in terrific shape, far outpacing their production divisions — to the point that GMAC made $818 million in the second quarter of this year while GM’s North American vehicle division made just $83 million. Notably, GM’s lease rate dropped to just 7.3 percent of sales last quarter from over 15 percent a year ago. In part, those weaker core profits can be chalked up to Detroit’s reluctance to trim production, even if it means they’re thinning their own cash reserves to help Americans buy cars. That buyers’ market shows little sign of dimming. Asks Sylvester: “As long as there’s zero-percent financing out there, how attractive is that?”

Ever more affordable
Plenty attractive, of course, if you’re a consumer. As if that weren’t enough, consider the amazing level of affordability among car buyers. The average American can now buy a vehicle with just 20 weeks of earnings, down from over 24 weeks in 1999, according to Comerica Bank’s Auto Affordability Index. Looking ahead, there seems to be little motivation to reverse that trend, especially with car makers worried about brand loyalty.

“I just, for the life of me, can’t see the leasing business picking up a great deal in the next 18 months,” says David Littmann, senior vice president and chief economist at Comerica. “Everybody wants to move the cars and to increase market share.”

All this has still happened, of course, amid a slack job market and lagging consumer confidence. For the auto industry, at least, low interest rates have been great as an economic engine. But if the economy grows in the next year and interest rates creep back up, those great purchase deals could dry up. To that end, says Paul Taylor, chief economist at the National Automobile Dealers Association, we may be nearing the bottom of the pricing curve, meaning deal hunters shouldn’t tarry too long on their way back to the lot. “You have to call this a window of opportunity,” Taylor says.

Leasing's bright spots
There are still some bright spots in the lease market. Some companies still want the flexibility of leasing. Many foreign automakers, such as Audi, still see a healthy lease business in more expensive models. As prices spin upward into the luxury range, low-rate financing options often vanish, leaving a buyer with a monthly payment that can seem more like a mortgage than a car loan.

At the same time, there are some drivers who simply want to keep themselves in new cars without the hassle of buying outright. It is for such folks that GM offers its “lease pull-ahead” programs, which allow some GM lease holders to turn in their vehicles before the lease expires and start a new lease with a new car. As Struve puts it, “You’ve got customers who just like turning over vehicles.”

But even among those customers — the ones who still endorse the 1950s concept that had drivers trading in for a new model every couple years — the numbers make a good case for buying.

Should low rates taper off and should buying, as Taylor predicts, become a pricier proposition, leases could gain traction again. Even if that happens, automakers are unlikely to raise residual lease values for a while, hestitant to repeat the problems of the past few years. “I don’t think anybody’s sticking his neck out,” says Littmann.

Actually, that could lead to one potential bonus for lease fans. If residual values dip below used-car book figures, lease holders could buy out their lease and then immediately resell the car at a profit.

But leases seem unlikely to reignite the sort of frenzy they did in the 1990s. The lease market in New York state essentially dried up this month after state lawmakers failed to scuttle a law that makes lease firms (who actually hold a car’s title) liable for accidents. So long as the current model — lots of cars built, low prices, easy financing, high turnover on the lots — keeps turning out profits, there may be little incentive to mess with a good thing. “I think they’re going to stay away from leasing,” Healy predicts, “because they’ve gotten burned too often.”