How rising depreciation will affect the used-vehicle market

Used-vehicle depreciation is expected to climb this year as the factors that helped keep it at a lower rate in 2018 appear to be petering out.

Relatively low interest rates, good credit availability, high job growth and tax cuts all came together to put the used-vehicle depreciation rate at 12.4 percent in 2018, compared with 13.2 percent in 2017 and 17.3 percent in 2016, according to data company Black Book.

"We kind of hit a peak on some of these factors that made depreciation very low," Anil Goyal, Black Book's executive vice president of operations, said of the 2018 rate.

Black Book expects the rate, which measures annual depreciation on 2- to 6-year-old vehicles, to grow to 15 percent this year, Goyal said, as the favorable factors from 2018 cool off.

For residual values, the other side of the depreciation coin, TrueCar's ALG, which tracks 1- to 5-year-old vehicles, expects a consistent decline of about 0.5 percent annually over the next three years.

Here are some noteworthy trends analysts are watching in 2019 and beyond:

Although automakers have been fairly disciplined on incentives, high inventory of new cars and trucks in the U.S. has analysts saying that something has to give. This is even after the peak of off-lease vehicle returns, expected to be this year, said Eric Lyman, ALG's chief industry analyst.

"With used supply now plateauing, we're shifting over to seeing incentives be the most significant driver of putting pressure on used-car values over the next few years," Lyman said.

Calling it a long-term assessment, Lyman said ALG reaches that conclusion by looking at all new and used registered vehicles in the U.S., which is about 275 million cars and trucks. The company takes that total inventory and weighs how many vehicles are being registered against total demand coming from individuals at the legal driving age, as well as other metrics such as the scrappage rate and how many registered vehicles there are per driver.

"Where we look at that supply versus demand, we're seeing that with the number of new vehicles being produced every year, it has been outstripping the number of vehicles that are coming out of the car park," Lyman said.

ALG and Black Book estimate there are about 4 million excess vehicles.

"It's not quite as traumatic as it sounds as far as an oversupply of 4 million vehicles," Lyman said. "But something has to give when you start pushing more vehicles in there."

The most obvious lever is incentives. Higher incentives typically drive down residual values for used vehicles.

The continued shift toward light-truck production at the expense of cars is having a corresponding effect on depreciation and used-car values.

Lyman said ALG still sees about a 5 percent premium in terms of residual values of utilities vs. cars. This speaks to the continued demand for crossovers and SUVs.

But, he added, "We are seeing an increase in [residuals for] midsize, compact and subcompact cars."

Lyman said it appears to be a function of the shift in the vehicle mix reaching the used-vehicle supply and subsequently putting it more in line with demand. The general drop in used-car supply is driving used-car values higher.

Goyal echoed that sentiment.

"There's not as [many] choices available" for cars, he said. Automakers began dumping deals on cars about three years ago as buyers favored crossovers and SUVs. Now, the market is seeing a bounce off low prices for cars, he said.

Goyal also said it appears that the price disparity between high-demand compact crossovers and compact cars is now large enough that some buyers are opting for the more affordable compact cars.

"There's just so much of that substitution in transportation, between new and used," Goyal said. "There's a lot of interplay between how the production levels work in one segment, how the new prices versus the used are or how one segment is priced lower."

Luxury segments have traditionally lagged mainstream ones for retained value, but that spread appears to be growing, especially on the luxury car side.

Black Book said in an April report that the separation usually ranges from 3 to 5 percentage points for midsize luxury cars vs. their mainstream counterparts. But in 2018, that separation stretched to an 8-percentage-point gap.

Luxury-brand used-vehicle values in general are suffering from a mix that has traditionally favored sedans.

"They're still sort of working their way through that shift, and that's put some pressure on some of their values as well," Lyman said.

Lyman doesn't expect luxury cars to do much better going forward, as incentives will likely put further pressure on retained values. With U.S. luxury sales in decline, some luxury marques — Mercedes-Benz, for instance — are spending more on incentives so far this year.

Pickups — full-size and midsize — topped all vehicle types in ALG's 36-month forecast of residual values in its first-quarter report.

"Demand just continues to be so strong in these segments," Lyman said.

And competition is expected to further heat up. Along with relatively recent redesigns for major full-size pickups such as the Ram 1500, Chevrolet Silverado and GMC Sierra, newcomers such as the revived-for-North America Ford Ranger and the Jeep Gladiator are arriving this year in the midsize category. Nissan is also expected at some point to add a redesigned Frontier.

At the same time, Lyman said the pickup segment is seeing big dollars in both absolute terms and in incentives being offered. The higher the segment gets, the further it could tumble, however. Pickups are typically the first segment hurt by an economic downturn because sales often are tied to homebuilding, contractors and small businesses.

All told, Lyman said the pickup segment is "probably the most fascinating, and the one that we're paying a lot of attention to."