We have seen this before: Disruptive economic shocks such as the one we are in bring tremendous risks along with ample opportunities.
There are lessons to learn from prior crises such as 9/11 and the financial crash of 2008. In those cases, the first shock, a period of demand freeze, was followed by a second shock of a sharp drop in consumer confidence. Eventually, shifts in supply and demand curves caused pre-owned vehicle values to crash, costing finance companies and auto dealers billions of dollars.
The economic paralysis from the COVID-19 lockdowns has damaged consumer confidence and, combined with record off-lease supply and new-car incentives, created a perfect storm hitting dealerships.
Industry analysts have coalesced around three economic scenarios:
- Mild recession: A V-shaped recovery with prices for 1- to 6-year-old pre-owned cars declining 10 to 12 percent.
- Moderate recession: A recovery with prices declining 14 to 17 percent over the coming months.
- Severe recession: With more than 30 million Americans having filed for unemployment (a level not seen since the Great Depression), the chance of severe recession and a slow, U-shaped recovery — with 22 to 25 percent declines in pre-owned prices — cannot be dismissed.
Three forces are converging that will swamp the values of pre-owned vehicle inventory, creating the risk of massive losses from current inventory while ultimately creating incredible profit-making opportunities:
1. Record off-lease supply: There is unprecedented supply pressure driven by a record of nearly 4.1 million off-lease maturities in 2020 (60 percent more than 2015) and massive liquidations of rental car inventories. There are 1.8 million additional vehicles due off lease between March and July alone. Managers of off-lease portfolios are letting inventory pile up at auctions — more than 800,000 overflow vehicles were sitting on auction lots as of April. In past crises, this has led to crashes in vehicle values once this logjam breaks. Any wholesale price drops before this happens may be a mirage, not an opportunity.
2. Damaged consumer confidence/demand freeze: The demand freeze took hold quickly as the shelter-in-place orders spread. Consumer confidence will fall further because of economic uncertainty from unprecedented unemployment. Retail pricing has not yet corrected significantly.
3. New-car incentives: Automaker incentives will spark new-car buying while further depressing used-car values, especially for 1- to 3-year-old pre-owned cars.
How can you safely navigate this perfect storm?
- Beware of the "trade-in overpayment zone" while the gap between retail and wholesale prices remains large.
- Take advantage of the "retail out zone" available now to retail aggressively out of pre-crisis inventory where F&I profit can help offset any potential losses.
- Run lean until prices correct and the "restocking zone" window opens.
When is it safe to restock? Once the major off-lease backlog begins to work its way through auctions at low no-sale rates, prices will correct to the "new normal" and it will be time to restock. We aren't there yet — don't try to catch a falling knife. At the same time, watch manufacturers that have closed factories and keep an eye on new-vehicle days supply, especially for trucks. These are the only vehicles likely to beat the price trends above.
Even at the individual vehicle level, there are few vehicles ready for repurchase profitably. Most vehicle level-pricing alerts in our system are indicating between $1,200 and $5,500 in reductions still to come. At any price above the expected future value, dealerships are taking on additional risk of loss.
Remain flexible as conditions change. Keep an eye on the auctions, changing new-car incentives and new-car days supply for manufacturers with extended factory closures. You still have to put deals together and may not be able to wait for ideal conditions to buy. When appraising, educate your customers and beware of giving back your new-car profit by taking in underwater trade-ins. You know your market and customers better than anyone.
Remain disciplined and use all the market data available, paired with your sales data and local understanding, to help your dealership perform well in this challenging market.
