There was a lot of buzz about leasing at February’s NADA Convention. Recent numbers indicate the pickup in leasing last year will continue in 2012, but is there a limit to how much this transaction type can grow? That’s up to the manufacturers, and a little history lesson might provide some clarity on just how far they will take it.
Yes, there has been an obvious resurgence in new-vehicle leasing, but consider the source: Dealers who are reporting any significant increase are doing it as a result of heavily advertised and factory-subsidized incentive programs. The brands that don’t have these incentives are still delivering a relatively small percentage of leases.
The big question is why some in the industry would think leasing is a good thing when dealers currently have access to the lowest interest rates in recent memory. Well, from the manufacturers’ standpoint, leasing represents a way for them to sell more new vehicles — not only today, but three years from now, when those leases expire. It’s good for the manufacturer lending arms as well, as they are only committing their money supply for three years instead of five, six or seven.
Leasing can be good for dealers, too. Gross profits, brand loyalty and dealer retention are much higher on leases than on retail deals, and a 36-month lease brings customers back to the market much faster than a long-term retail finance deal. Lease-return vehicles also are critical to restocking the used-car market, which helps bring prices down.
And let’s not forget the customer. In one study, 44 percent of new-car buyers owed more on their trade-in than the trade allowance shown on the retail order. Leasing solves this problem and allows the customer to drive a car they might not be able to buy.
Growing Pains
But before we get too excited about the potential growth of leasing, let’s run through that history lesson I mentioned earlier. There have always been specific market conditions that cause higher levels of leasing, just as there are conditions that cause it to become less popular.
Leasing first began to gain traction in the early 1980s. At the time, the industry struggled to recover from the debacle of the mid-to-late ’70s, when clean, late-model used cars were in short supply and interest rates on conventional loans were fairly high. Manufacturers and dealers looked to leasing as a way to get people into new cars.
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The company that really caused the leasing “boom” of the 1980s was Ford Credit and its Red Carpet Lease program. By the middle of that decade, Ford’s captive arm began aggressively marketing its entry-level vehicles to people with marginal or very little credit by approving them for two- or three-year leases at a payment that was the same or less than that of a used car. They were able to buy anyone with a job and a pulse, and America’s highways were filled with shiny beige and light green, base-model Escorts and Tauruses. It was a brilliant program.
But after a few years, things started to change. First, the increased supply of those off-lease vehicles caused used prices to drop. While that seemed like a good thing to dealers, the lenders were taking it on the chops because of their inflated residual value estimates.
I remember standing in the lane at the auction back then, buying three-year-old cars for $2,000 below what I knew was the residual value the lender used to compute the original lease. As a result, residual values plummeted to the point where leases just weren’t a good deal any more.
Interest rates on conventional car loans then began to drop as well, making leasing less attractive to consumers. To reduce the payments, dealers started extending the terms on leases to 48 or 60 months. As a result, the percentage of leased vehicles declined dramatically.
