Is there a Big Profit Opportunity Many Dealers are Missing?

By Joe Overby, Staff Writer
July 21, 2008

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CARY, N.C. — Dealers are getting their margins squeezed on both new and used sales, driving a need for them to focus their attention on other profit avenues to bolster bottom lines. There is one opportunity that's been around for many years but remains widely untapped. What is it?

A little-known resource that can help dealers recoup some of their losses in these tight economic times is used-vehicle leasing, according to David Ruggles, a partner with CyberCalc Arbitrage.

"If dealers are going to make up for the shortfall, its going to be on pre-owned leasing," Ruggles noted.

Used leasing can be very risky, which is partly why many dealers are averse to it. But if utilized properly, CyberCalc can help reduce these risks by providing information to help dealers identify used vehicles well-positioned for leasing.

So how does this work?

Sometimes, when certain models come off-lease or off-rental and enter back into the remarketing lanes, they go for lower-than-average wholesale prices. This presents an opportunity for dealers to snatch these vehicles up at low prices. This type of thing often occurs when there is a sudden surge of vehicles coming off-lease then going into the remarketing arena, or if there is flood of rental units of one particular make.

So how does CyberCalc come in? It can help dealers identify which of these low-priced vehicles will hold their values well, so that they can be quickly snagged and leased out before the residual changes.

Essentially, CyberCalc provides a list of used vehicles that includes an index, which is a percentage representing a vehicle's residual value divided by its current wholesale price.

In other words, the greater the index, the more potential a model has at maintaining its value at the end of a lease term.

The CyberCalc site also provides approximate monthly payments and a general idea of where dealers can find these potentially profitable vehicles.

To set its index, CyberCalc uses the Automotive Lease Guide, which posts residual values every two months.

Once the units are identified, dealers can lease these models out to consumers based on ALG's average residual expectations, meaning that a dealer has a bigger built-in profit opportunity since he initially paid lower-than-average wholesale prices.

When the vehicle comes back to the dealer after the lease term is up, its value is roughly the same it was when he purchased it wholesale.

According to Ruggles, successful dealers "identify vehicles of opportunity and they buy them in quantity." Why are these vehicles such a steal?

Ruggles said his program removes much of this danger. With used vehicles, the bulk of the residual risk is already gone after the vehicle rolled off the lot as brand new. Used vehicles generally do not depreciate as quickly as new vehicles.

So basically, a dealer is buying a unit today at a price that's practically guaranteed to be the same as its residual value two or three years down the road.

So why, then, are some dealers and OEMs, resistant to used or certified leasing, especially given the growing popularity of CPO units?

For starters, there there's not an incredibly large pool of available pre-owned vehicles made after 2005, Ruggles noted.

Moreover, "It's a function of money," Ruggles pointed out. Many OEMs don't have the cash to put behind CPO leasing because of market uncertainty

Therefore, Ruggles indicated that "they have left CPO leasing to individual lenders and dealers."

There are several other pluses to pre-owned leasing that can outweigh the risks. One is the strong sales pitch that can be made to consumers. To their benefit, dealers can highlight the following as selling points:

—Shortened trading cycle

—Lower monthly payments. By using Arbitrage, dealers can offer payment plans for 36-month leases that are roughly equal to or lower than those for traditional, long-term financing.

—More vehicle for less money

—Less capital used

—Potential tax advantages

Meanwhile, the industry can benefit by:

—Acquisition fees

—Money factor revenue

—Depreciation tax credits

—Increased market penetration

Despite the hesitation of some dealers and lenders to fully embrace the concept, there have been those who have been quite successful with used leasing.

When it comes to illustrating a success story, Ruggles points to the Lake Michigan Auto Center in Hudsonville, Mich.

By using CyberCalc, the store's general manager Maury Dikker found a plethora of unsold 2007 Suzuki XL7 models.

Knowing that he could purchase these for lower-than-average wholesale prices, Dikker committed to 40 of them.

After marking them up by $1,500, he was able to offer a lease special of $148.33 per month for two years, which can prove very attractive to consumers.

"They used Arbitrage as a vehicle of opportunity," Ruggles noted. "To be able to lease a year-old vehicle for $150 is too good to be true. People will come out just to see if it's possible."

Judging by the results of the sale, it's not only possible, it's profitable.

Dikker moved the entire allotment in three weeks, including a day where 13 Suzukis were leased.

Now, as Ruggles puts it, Dikker has a pool of 40 customers he can do business with again in two years. Had his customers opted for a traditional 60-month retail financing, payments would have been roughly $300 a month and likely it would have been much longer before his customers returned to the market for another unit.
While such dramatic success as Dikker's may seem surprising or unlikely to some, if the game is played right, those kinds of results are entirely possible, according to Ruggles.

"Maury is a real student of the business. He's going to look at (Arbitrage) and learn everything about it," Ruggles stated.

"For him to take 40 of them, he bit off a pretty big mouthful. But knew at that price, they were going to go very quickly," he continued. "I would say that if you can offer something to the public at that price, they will vanish."

Offering a word to the wise, though, Ruggles said, buy these models at the beginning of the two-month period when ALG sets residuals.

"The thing that Maury also recognized is that if a dealer is going to play the game, he has to buy at the beginning of an ALG book period. Because who knows what will happen to the residual value of the vehicle?" Ruggles added. "Timing is essential."

Also essential is knowing which vehicle segments offer the biggest potential profits at any given time.

Not surprisingly, showing the most opportunity as of late have been "gas-guzzling" SUVs.

Take the example of a 2005 Cadillac Escalade ESV.

At one point last week, the SUV had a wholesale price of $17,500, which was down $6,000 from a few weeks prior, according to Cybercalc.

The residual value of the particular Escalade, however, is still $17,299 in three years, based on Standard Finance Leasing (a lender based in Plano, Texas).

Assuming fixed mark-up of $2,500, Ruggles explained, a dealer can offer a 39-month lease at $184.65 per month.

"The market for gas-guzzlers has gone through the floor. It's an awful thing. For dealers who had these vehicles in their inventory, they have inventory that's so over-valued, there's no real thing they can do, except writing them down to real price," Ruggles reported.

However, just because wholesale values drop doesn't mean residuals will do the same thing. More often than not, residuals do not drop as quickly.

"The market has gone down substantially, but the residual values have not gone down at the same rate," Ruggles explained.

If fact, Ruggles suggests that previous owners of large SUVs will eventually grow tired of the smaller cars they traded-in for and may soon want to go back to bigger vehicles.

So, if fuel prices stabilize, the pendulum could swing back the opposite way. Hence the cyclical nature of the industry.

"There will be a time in the foreseeable future where there will be a stampede away from small cars, just like there is a stampede toward them (now)," Ruggles forecasted.

Often, he noted, people make judgments based on speculation or perception. But when residual values are set by ALG, it is based on an understanding of the market's cyclical nature.

"ALG is not panicking," he went on to add. "They've been through these cycles before and they understand that even these so-called gas-guzzlers are at a low point now, that doesn't mean they'll be at a low point a few months from now."

But the question arises, are the benefits of used-vehicle leasing a double-edged sword?

"There is a perception out there. We try to limit the number of subscribers in a particular market," Ruggles noted. "If everyone in the same market is chasing after cars, it's going to have an effect on the price of the cars."

In other words, if more and more dealers go after a specific vehicle with a low wholesale value, the price of that vehicle tends to go up as competition and bidding heats up.

Summing up, what lies ahead for the future of used-vehicle leasing? Ruggles indicated that it will remain very much viable in the months and years to come.

"It's been sustainable for 28 years, so as long as there are markets and as long as there are leases, the concept is sound," he explained. "There are lenders that have come and gone, and quite frankly, at some point, if OEMs have firm commitment to their CPO programs, they will have to offer some sort of leasing for CPO."

For more information, visit www.cybercalc.com.