A car is one of the biggest purchases a person will make in
their lifetime. But unlike a house, a car starts losing value
right away, literally as you drive it off the lot.
You could keep it spotless inside and out, give it regular
maintenance and protect it against every ding, dent and scratch and
it'll still lose value.
Depreciation. The rate at which that happens is one of those
numbers everyone in the automotive world thinks about.
Consumers, automakers and the massive used car market, which
makes up somewhere around 40 million sales each year, more than
double the sales of new cars.
But in 2020, something strange started happening, turning the car
market upside down.
Used vehicles were actually increasing for about two years,
which we've never seen anything like that for the for the market.
A lot of those trends have abated since, but those odd times led to
lasting changes in the post-pandemic world.
There are fewer cars to go around, and prices for both new and used
vehicles are still high.
That is unlikely to change for a while.
In addition, a lot of car purchases are financed, which means
if the resale value of the car dips too low, a buyer could end up
paying more for the car than it is worth.
That is what it means to be underwater on a loan.
Similarly, automakers want their cars to hold as much value as
possible, in part because they know customers care about that.
Depreciation also affects how automakers charge for leases, which
are an effective way of drawing in new customers but are expensive to
run for automakers.
Every car depreciates differently.
Luxury cars lose value.
The fastest sedans lose value faster than SUVs, and cars from
brands with strong reputations for quality and reliability depreciate
more slowly. But on average, cars lose about 10% of their value as
soon as you drive them off the lot.
There are a few reasons for this.
One is that we like new cars.
We we just like being in a brand new car and it's not brand new once
you take it off the lot.
The 10% loss in value corresponds almost exactly with another
specific number.
And that number, say some insiders, is the primary reason a
vehicle's value drops that much in the first day of ownership
incentives. Most new cars are sold with incentives at one point or
another. When first purchased by a consumer, an incentive is a
discount on a vehicle provided by a manufacturer or dealer to induce
people to buy it prior to the pandemic.
The average incentive on a vehicle was about 10%.
That means on average, new vehicles were sold for about 90% of
their MSRP or manufacturer's suggested retail price.
And so that car you bought seems to drop by 10% in value the moment
you drive it off the lot.
What is actually happening is that the market is pricing in the
probability you received a 10% discount or incentive on that
vehicle, even if you didn't.
It's kind of a messy part of how we do things, because we can't go back
and see what the average transaction price is.
But we know historically what MSRP is on a year, make model
combination. And so we can go see the value of that car against its
original MSRP.
Another factor when you sell your car.
Chances are you are often selling or trading it back in at a
dealership. The dealer is going to offer you the wholesale price on
the vehicle. What the vehicle would fetch at a wholesale market
like a dealer auction, those prices are always lower than the
retail price. What?
The dealer would sell it to another consumer for, as there are
additional costs and margin that need to be absorbed.
That lower wholesale value also makes up part of the depreciation.
Consumers see and feel higher priced cars have higher markups or
variance, so there is an even bigger gap between their retail
price and wholesale value.
But there is a third reason why cars lose value so quickly.
An economist named George Akerlof won a Nobel Prize for coming up
with this idea.
Akerlof's famous paper is called The Market for lemons, and the idea
works like this.
In any market, there are information asymmetries.
This means sellers know more about the product they are selling than
potential buyers do.
If you have a car and it's like three days old or three months old
and you sell it, why would you do that?
If the car was a good car, you're probably doing it because the car
is a lemon.
From that first day drop, a car's value slides further about another
10% throughout the first year.
In the second and third year, it drops again and again.
Estimates of how much can vary depending on who you talk to and
what they are measuring.
Again, a car will fetch less money on a wholesale market than it will
on a retail market, and maybe during a transaction between a
private buyer and seller.
In normal times, a steady supply of new vehicles year after year is
enough to drive the value of any given car down.
Add to that the normal wear and tear that comes with ownership.
It's like your tires wear out you.
You may get dings in your door over time.
You know, maybe there's a crack in your windshield.
Maybe your kid spills juice in the back seat and the, you know, the
upholstery is messed up and all of that's just wear and tear on a car,
which means that, um, it's it's not worth what it originally was.
Or to put it back in that state, someone would have to invest money
to recondition the car back.
After about three years.
Vehicles, on average, historically held about 50% of their value.
Three years is a kind of benchmark for the used car market, because
that is the typical time for a lease, and leased vehicles are a
large source of vehicles for the used market.
There are exceptions to this, of course.
Exotic cars, collector cars, limited editions.
Any car that is highly valuable won't depreciate normally and can
even appreciate it is rare for a car to appreciate or increase in
value, but those are some that do.
You know if you if you like it enough to buy it a new, you might
actually sell it for profit.
Uh, some OEMs are trying to fight that.
I think Tesla just had a, uh, in their agreement and they just pull
it back again. So you cannot resell their Cybertruck for a year.
At one point, Tesla even threatened to sue resellers for $50,000.
It reportedly removed the clause from its user agreement in
mid-November 2023, just days before the truck's release, and
then reinstated it when Cybertrucks started popping up for
sale on the internet.
This was also true of exotics like the Ford GT.
Ford sued wrestler and actor John Cena for reselling his Ford GT less
than a year after purchasing during the Covid 19 pandemic, as
people stayed away from public transportation and flying, used car
values skyrocketed by somewhere around 30%.
Take your and or $10,000 used car and, uh, by by by the end of that
year it was $13,000.
So people were buying cars, driving them for a year and then
selling them for profit.
It's it's still your economy.
101 strong demand, short supply prices went up.
It was just to the extreme they've never seen before.
On top of it all, production shutdowns and supply chain and chip
shortages limited the number of cars in the marketplace.
Automakers weren't leasing or selling cars into fleets such as
rental agencies.
The few cars they were selling were higher priced vehicles that
help maximize profits.
There were no incentives.
New vehicle supply didn't meet demand, though, which drove
customers into the used market.
Even rental companies, which had sold off a lot of their fleets at
the beginning of the pandemic, were buying used cars at auction to
satisfy their own customers.
We had two very distinct periods of vehicle appreciation, which is
unheard of. You know, we we had prices that moved up into the
spring and early early summer in 2021.
And then they kind of went sideways.
And then we got to August, September and they moved up again.
And so we ended that year with vehicle prices and values that were
much, much higher than what anyone was used to.
Fewer new cars in 2020 means fewer used cars in 2023 and 2024.
That pandemic price bump has evened out a bit, but cars are
holding on to about 60% of their value after three years.
A 10% increase from pre-pandemic times.
We expect some normal, more normal seasonality, more normal
depreciation, but the baseline for prices is going to be elevated.
So we've reset prices at a high level.
A lot of the goods and materials that go into producing a car are
still sitting at high levels.
Even though inflation is coming down.
We're not in a period of deflation.
It's it's highly unlikely that we're going to go back to to having
lower car values.
The Federal Reserve has raised interest rates in order to rein in
inflation, and that has made borrowing more expensive.
In the second quarter of 2023, almost 80% of new cars were
financed and more than 30% of used ones.
Incentives have increased, some from the lows they're in, but not
nearly enough to offset.
The average new car price right now is almost 30% higher than it
was pre pre-pandemic time periods.
New vehicle production and sales are also about 2 million units,
below the record 17.6 million units hit in 2016.
That year, the average transaction price was around $34,077.
Average transaction prices in October 2023 were around $48,126.
A lot of analysts think that as long as prices stay that high, it
will be hard to hit those record volume numbers, and that might be
just fine for automakers.
A lot of the OEMs have said publicly they don't want to sell
that level of new cars.
You know, that they're they're trying to be smarter about
producing and over producing cars and having to over incentivize cars
to keep their profits high.
But this means that there will be fewer cars available.
A new car might only be sold once, but a used car can be, and often
is, sold several times.
Constraining the supply of new cars puts a cycle in motion, where
the supply of used cars is constrained over and over again.
One of the perhaps hidden benefits of depreciation is that it creates
a pool of cheap, used cars for buyers who can't afford anything
else. The price of a new car in October 2023 was close to $50,000.
That is luxury territory.
It took almost 39 weeks, with a median American income to purchase
a new vehicle. That is down from a record high of more than 41 weeks
in December 2022, but still higher than the roughly 33 weeks in
October 2019.
It's the most important factor out there in the in the marketplace for
people. I think there's a lot of consumers that need a replacement
car that have been trying to do everything they can to not do that,
because they don't want to finance the car and they don't have, you
know, $25,000 or whatever to go just pay for it outright.
There is a market out there for an OEM that wants to build a more
basic product that's new and maybe decontented a little bit, too.
And whoever wants to go after that, I think somebody probably
will. I think they'll do really well because that's what consumers
need and want.