Used Vehicle Market Stretches History and Defies Labels

The automotive remarketing industry likely ranks among the few where economists brimming with slides and data can carry an audience for a period scraping an hour.

At the Conference of Automotive Remarketing on March 29, the annual industry economics and vehicle markets session for the first time brought together the four leading market observers.

While they vary in their analysis and views, their findings all point to a remarketing industry very much still influenced by the afterburn of the COVID era. High vehicle prices, solid residual values, inflationary pressures, and supply chain kinks will cause the overall industry market to gyrate like a surging fire hose for years to come.

CAR emcee Charlie Vogelheim moderated the four panelists, who each gave short presentations: Jonathan Smoke, chief economist for Cox Automotive; Tom Kontos, chief economist for ADESA and leader of ADESA analytical services; Dr. Alex Yurchenko, senior vice president and chief data science officer for Black Book; and Dr. John Coles, senior director of data science and analytics at ACV Auctions.

Macro Market Hits Affordability Bumps

In 2022, when a recession looked less likely, questions about financial stability and the recent bank failures resulted in tighter credit for auto loans across the traditional channels serviced by banks, credit unions, and captives, Smoke said. That tightening has loosened somewhat during the first quarter of 2023, but interest rates have continued to rise.

“Now it’s harder to get a loan for a consumer than it was before. Every lender tightened so far in March,” Smoke said.

Rates have continued to go up, and from a yield spread perspective, have widened to the most ever for banks and credit unions in the last eight years, he said.

Lenders pulled back lengthening of terms in vehicle markets, making vehicles less affordable. “We’re seeing auto loan rates go up dramatically due to Fed tightening.”

During the first three months of this year, the used auto loan rate rose more than 1.75 points, which is 14% of the used loan rate. In 2022, the rate went up three points.

By the end of Q1 2023, the average monthly payment for a new vehicle was $725; $648 for a new leased vehicle, and $549 for a used vehicle.

“With consumers paying even higher auto loan rates, it means that the yield spreads have widened,” Smoke said. “The other element is lenders have started to rein back lengthening of terms, and that has been one of the ways that have helped mitigate rising prices and interest rates, especially in the U.S. vehicle market.”

Smoke predicted a slowly improving supply situation, less credit availability, and affordability challenges will weigh on the used vehicle industry for the next few years. Continued Fed tightening has driven up auto loan rates. Coupled with above average prices, fewer median income households can afford the typical monthly payment of $549 for a used vehicle.

Also, many new vehicle buyers are shifting to the more comparatively affordable used vehicle market.

“Consumers are just having a tough time being able to make a vehicle purchase work, even though we're in the heart of tax refund season,” Smoke said.

Finding Market Ceilings and Floors

The used car market contributed to the national inflation levels last year, spurring a correction in U.S. vehicle prices, Kontos said. But the influence of used vehicle prices on inflation has dwindled so far this year, but still exists and likely will be factor in the near-term.

“It used to be our industry always had kind of a floor and a ceiling to prices,” Kontos said. “And the ceiling was always represented by what new car prices were doing. And new car prices present an upper limit, because you get to a point where the affordability of a used car will be good relative to a new car up until the used car price might be so high that the tradeoff is not one that consumers are willing to make. And that causes a decline in demand for used cars, which also softens used car prices. So that represents the ceiling.

“The floor is just the fact that usually there are times when there are ebbs and flows in the number of vehicles available in the used car market. We happen to be in an ebb since the used car supply is very light. We're still in what I call somewhat of a perfect drought. The off-lease units are in short supply and will remain so for at least a couple of years.”

Meanwhile, although repos are starting to rise, they are still only a fraction of normal levels, Kontos said. Dealers and consignors are holding on to as many trades as they take, and thereby reluctant to release them into wholesale channels. If they must, they find a way to retail out of those vehicles. That leaves a light consignment volume coming from commercial and rental fleets with supply still tight overall, he said.

Looking at inflation and consumer price index levels for vehicles, the pace was moving higher than the average inflation rate but seems to be leveling and likely won’t rise much faster, Kontos said.

“There are periods when there might be shortages of used cars, like we had after the 2008-09 recession. And we did see strong used car prices during that period, and the CPI was rising for used cars a little quicker than the new car CPI. But they stay at about one to one. And you can see that in 2021.”

The second half of 2022 was mostly a correction nearer normal levels of used car prices, Kontos said. “They're still about 30% higher than they were pre-pandemic. So, we're not getting back to 2019 kind of price levels. At the start of this year, we were surprised expecting spring market uptick, but we got it hitting the ground in January. I think that says dealers did a pretty good job of clearing out the vehicles they had bought at higher prices during 2022. And as prices were softening, they were being aggressive in pushing those vehicles through the retail channels and getting them sold.”

While inventory started lean in 2023, dealers retained decent quantities to sell during the spring tax season, Kontos said. That activity appears to be waning somewhat, as prices are in a better place than at the end of 2022 while down year over year. He predicted single digit variations for the rest of this year as used vehicles overall will remain in short supply.

Outlook for Vehicle Prices & Values

Yurchenko provided the audience with a historical overview of average used prices in the wholesale and retail markets, focusing on 2–6-year-old and 2-8-year-old vehicles. Before the pandemic, in 2018-19, the relationship was stable, with a separating margin of about $7,000.

With COVID on the scene, both wholesale and retail average prices rose. But the margins were on a roller coaster, he said, with wholesale prices increasing much faster than retail ones. By Q4 2022, retail prices were decreasing again, shrinking dealer margins, and leaving them lower than compared to the peak in the pre-COVID period.

He also cited another key change. “In a typical, normal market, there is a lag time between wholesale and retail vehicle movements, about six to seven weeks. Dealers are buying vehicles, which is reflected in the retail market later. We've seen a lot of changes in that dynamic, with dealers starting to buy vehicles much earlier this year for the spring market. So, wholesale prices started going up, and now we see retail prices rising much faster than we historically see.”

That along with geopolitical events such as the Ukrainian-Russian conflict and concerns about inflation and the economy have helped dissolve the usual seasonal cycles of buying and selling. Therefore, the question of whether the market will return to normal remains open.

“But if you look at first three months of the year, we're already in a different world. Prices are still increasing much faster than we've seen historically. We've seen weekly increases in the wholesale market of over half a percentage point for some segments and for others it's 1% a week. In a normal spring market, we've never seen that before. There is a very strong demand on the wholesale market and prices are going up.”

Yurchenko predicted the constrained vehicle supply from lower rental and fleet leasing returns will likely continue for a few more years and not recover soon.

“Fleet and rental companies are still having issues buying new inventory, so we’re not going to see a lot of those vehicles coming back to the market. Repossessions are increasing, but banks are doing a great job keeping the consumers in their vehicles. If you look at default rates, most of them at pre-pandemic levels, but lenders are trying to avoid their repossessions as much as they can.”

Prices will remain elevated due to two main reasons: 1) Lower inventory, 2) Lower incentives. Production remains challenged. “If you want a Toyota RAV4 hybrid, I’m sure it will take a few months to get it.

During the pandemic, prices climbed an average of 70% in wholesale vehicle markets and will still be up about 40% in the next few years because of low incentives and low supply increasing prices for 2–6-year-old vehicles.

While vehicle values were appreciating at unprecedented levels in 2020 and 2021, last year brought the start of depreciation again, which could likely add up to normal depreciation levels for this year, Yurchenko said.

“We don't expect normal seasonality, but for the whole year, we forecast somewhere around 18%, which is just a little bit higher than historic levels. I think we will get into some normal depreciation in the wholesale market.

However, prices will remain higher than pre-pandemic levels due to limited supply and low incentives. Across all segments and all ages, the wholesale market will continue to be strong compared to pre-COVID levels.

The 1970s Roar Back with Some Twists

Coles started with the base question for the session: “What can we learn about the historic period of the 1970s, as well as connecting to what we're seeing in the micro economic environment today?” Borrowing a line from that decade, Coles answered, “But the times, they are a repeating.”

Coles cited fuel challenges, high inflation, declining affordability for consumers in retail markets, and across new and used vehicles, as factors influencing the current economy.

“When we look back to the 1970s, this was a key period where we saw smaller vehicles be introduced more aggressively, and actually the appetite for these vehicles spiked significantly due to increasing costs of new vehicles,” Coles said. “When we look at the 2020s, you've got the pandemic, you've got fuel, you've got inflation; it sounds kind of similar. You've got international crisis, which you had multiple in the 70s, as well as the 20s. What differs in this decade is the consumer shift to electric vehicles, but that increases the cost of entry to new vehicles, Coles said.

“When we look at why there's consistent demand for those three-to-five-year-old vehicles, and even an increase over the last, we saw an increase in both used and retail demand and delivery during the first portion of the year compared to 2022,” he said. “That increased engagement highlights the need for affordability in the midst of credit tightening.”

What we're seeing compared to 2023 is an increase in new and used light vehicle SAAR (seasonally adjusted annual rate) in Q1. “Looking at the 1970s versus the present, and even all the way back to the 1940s, what we saw is that there were changes in the 70s, as well as post World War II that significantly spiked the cost of a new vehicle into the 1970s and 80s.  

“That was a period of consistently higher inflation levels. Even if we aren't saying, as [Federal Reserve Chairman Jerome] Powell previously said, it's transitory inflation, it's a little less transitory than he thought. The Fed is aggressively pushing those rates down. And when we look at a historic pattern, it's like the 1940s, where you saw an immediate spike, and then the new vehicle costs are likely to come down and become more affordable due to demand pressures. Meanwhile, among newer used vehicles, especially the three-to-five-year vehicles from OEMs that continue to struggle with chip and supply shortages, we anticipate those residual values to hold through the second half of this year and start attenuating slightly as new vehicle deliveries pick up.”

Coles mentioned how he was recently offered $8,000 more than what he paid for his Toyota RAV4.

“What we're seeing with specific OEMs is they are desperately trying to get affordable vehicles back on their lots to maintain consumer engagement as they work to get their supply lines back up and running.”

With the introduction of EVs and newer technologies, the market has seen an increase annually for the last two years of the new car cost, Coles said. While that can partly be attributed to supply chain challenges, new electric vehicles and other technologies indicate new vehicle trends are being pushed up, which leaves an opportunity for lower cost EVs to disrupt this market.

Used retail is affected by affordability headwinds, which is driving the real-time marketplace, he said. In each of the ACV auctions, and with their dealers, used retail vehicle affordability is key to the engine.

“As we look to the back half of the year, our dealers are looking for affordable inventory at every level of the supply line. They're trying to have something affordable for that family that cannot handle a $700 a month payment.”

Based on the data of last year’s decline in sales, “we’ve lost about 10% of the potential market overall when you look across new and used vehicles, and we won’t see those numbers improve until you start to see vehicles depreciating again, and interest rates no longer going up. At the very least we will see a bit of a repeat of what we had last spring and summer as we progress.”

Reduced demand with even tighter supply means the overall vehicle market hasn’t changed in a macro-sense in the last three years, he said.

“Normally we would have grown by 14 million to 16 million during that time, and that didn’t happen. We have more people in the country, more households, more jobs, more drivers, and that is Economics 101.”

More Remarketing Tidbits

Among other observations during a panel roundtable Q&A:

• Although annual vehicle production declines during the pandemic have led to an estimated shortage of eight million new vehicles, that does not necessarily mean pent up demand. If eight million vehicles were suddenly added to the market, it would not result in immediate sales, since they wouldn’t be offered at 2019 prices and low interest rates.
• Longer loan terms for new vehicles, with some spanning up to 84 months, simply delay the entry of normal used vehicle supply into the market as consumers hold on to their new vehicles longer.
• The supply stream is further constrained by fewer lease returns of one- to two-year-old vehicles. The number of vehicles coming from fleets and rental car companies is down by 50%. The market will not see as many vehicles in the next three years as it did in pre-pandemic years, which means retention and residual values will remain inflated. Last year, for example, three-year-old vehicles had 80% average retention.
• When looking across vehicle classes and factoring in the push toward electric vehicles, the market is seeing much higher residual values for hybrid vehicles because they are a tipping point in between EVs and ICE vehicles. Hybrids, especially trucks and small to medium sized sedans, appeal to many consumers wanting to save on fuel costs but not ready to leap into EVs.
• The largest sales increases are seen among lower-priced small and mid-sized vehicles, which then makes them less affordable.
• The market for delivery vans shows signs of loosening as more new supply comes online and fleets are releasing used vans that they’ve been holding on to longer than usual.
• Future electric vehicle resale values will mostly be tied to the battery and its charging and driving history. Mileage will be less important. EV values are still at an early stage, with EVs comprising only 1% of all wholesale vehicle transactions last year. EVs are competing with an older version of themselves and are moving through remarketing channels at a faster pace than that of ICE vehicles. Year to date, EVs are performing strongly in terms of values, despite price competition in the new EV market.

Originally posted on Automotive Fleet