While it seems as if the electric vehicle is not a new phenomenon, the EV market is in its infancy compared to the internal combustion engine vehicle market. The latter has a history of well over a century, while the former has been just a sliver of the American vehicle market until just recently.

Of course, by its very nature, the used electric vehicle market lags the new EV market. At the same time, it is critical to track both markets and draw the proper correlations to understand the current situation and get a look at the future. Without viewing the two conjoined markets analytically, it is impossible to predict residual values accurately. Poorly set residuals can have multi-million-dollar consequences, something J.D. Power’s ALG is very scrupulous to avoid.

Computing EV residuals requires a keen understanding of how the new- and used-vehicle markets work. There’s a very strong correlation between new vehicle transaction prices and used-vehicle transaction prices for all types of vehicles. But plotting EV residuals is complicated by the fact that the new and used EV markets are far less mature than the markets for new and used ICE vehicles. To perform this effort properly, knowing the expectations for EV sales growth and the relationship of new EV sales versus used supply of EVs is critical. Additionally, incentives from the original equipment manufacturers and the federal tax credits have an impact on both new and used prices.

Our expectation for EV sales in 2023 is about 10% market share. That represents about a 4-percentage-point gain from what we saw in 2022 when EVs were just below 6% market share. The expectations are for quite a bit of growth, with a substantial portion coming from new entrants into the market. Currently, mainstream and premium utility vehicles account for the bulk of the growth, which is probably no surprise to anyone who knows what type of vehicles are in demand.

In the U.S., the EV market has been stimulated by federal income tax credits, and the rules involving those tax creditors changed significantly at the beginning of this year. The two manufacturers who had oversold their tax credit limit under the previous rules — Tesla and General Motors — have regained the ability to offer their customers federal tax credits. Other brands, particularly import brands that build EVs overseas, lost the ability to offer customers eligibility for tax credits, except when those customers lease.

In the past few months, we’ve seen an increase in lease penetration for electric vehicles, pretty much across the board, utilizing the “45W” tax credit on leasing. Previously, leasing was not a significant portion of EV sales, but the penetration rate of leased electric vehicles increased this year as consumers and the OEMs took advantage of what is essentially a loophole in the Inflation Reduction Act. Leasing did not represent a substantial portion of EV sales in 2022, but with the rules changes connected to the IRA, leasing of EVs currently represents about 49% of all EV sales.

Further, the trend to leased EVs will impact EV residuals going forward because it changes the market dynamics and vehicle supply. Because of leasing, more used EVs will return to the market sooner than if those same vehicles had been purchased. That will tend to depress used EV values in two to three years.

On the other hand, additional factors suggest an improvement in EV residuals going forward. To level set, current EV residuals are not as strong as ICE residuals. 2020 model year electric vehicles returning to the market in 2023 retain about 59% of their original manufacturer’s suggested retail price (MSRP). Remove Tesla from that equation, and value retention drops to about 50%. In comparison, 2020 model-year ICE vehicles, in the aggregate, retain about 71% of their original MSRP today.

While 2020 model-year EVs retain quite a bit less value than their ICE counterparts, this will change. For one thing, ICE used-vehicle value retention will decline as the market eases from post-COVID scarcity. But beyond that, EVs will get significantly better and more competitive with conventional ICE vehicles. As future EVs add capabilities that make them more like current ICE vehicles in range, price, and capabilities, we expect to see EV residuals approach those of ICE vehicles.

Forecasting 2023 model year vehicles returning in 2026, EVs are expected to retain about 50% of MSRP versus the ICE vehicles at about 52%. So the gap is closing. New entrants have more range, higher performance output, and advanced technology. Automakers are putting the latest and greatest technology and safety equipment onto their electric vehicles, and those features specifically have strong value retention in the U.S. market.

Pricing is one of the biggest reasons we’re not seeing value retention parity. The MSRPs of EVs are still higher than equivalent ICE vehicles. Of course, residual value forecasting takes incentives into account too. If there are higher incentives on electric vehicles than their ICE counterparts, as is often the case, that will put some negative pressure on value retention three years down the road.

As I said at the top, the new and used EV markets are in their infancy compared to the century-plus new and used ICE markets. Until this year, EVs have never come close to achieving 10% of the new-vehicle market in the U.S. Even more to the point, until 2022, EVs represented less than 1% of U.S. supply of vehicles in the zero to five-year-old range. But we are expecting to see growth over the next several years. In 2026, when new EVs will represent about 27% of all new-vehicle sales in the U.S., we expect EVs to make up 8% of the U.S. supply of zero to 5-year-old vehicles.

That will mark significant progress, but more must be done if EVs are to comprise more than 60% of new-vehicle sales in 2030, as the Environmental Protection Agency postulated earlier this year. Vehicle range, electric charging infrastructure, and price are all crucial factors that must continue to be addressed if more American consumers are to be persuaded to purchase electric vehicles.

Kristen Lanzavecchia is director of industry solutions at J.D. Power Valuation Services