Residual value, the keystone of leasing and used vehicles

You may have already rented a car. Or you've opted for one of the multi-option options where, at the end of the period, you can keep the car, return it, or exchange it for another. Then you've surely heard of the concept of residual value, a variable that is also closely considered in used vehicles.

But before explaining what it is, we'll tell you a real-life story.

Years ago, a relative of this writer was able to get his first company car through leasing. "Fantastic," he thought, "I'll be able to have the one I've always wanted." Specifically, a Subaru Outback. However, when the operator did the math, it didn't add up. The monthly payment for the Subaru was much higher than that of the Mercedes GLC he ended up taking. The reason: the Japanese model's value at the end of the contract was much lower, and the leasing company was also aware that it would take much more time and effort to sell it as a used car.

Value that a car retains

"Residual value is the value a car can maintain after a certain period of time and mileage. It's the opposite of depreciation and can be measured in absolute terms—euros—or as a percentage of the original price," explains Ana Azofra, head of Residual Values ​​and Insights for Spain and Southern Europe at Eurotax, part of the Autovista group, the European leader in automotive price estimation.

Let's take another example: a new passenger car (VN) that cost €30,000 three years ago may now have a residual of €17,000, or 57%. In other words, it would have depreciated by 33%, or lost €13,000.

Past or future

This would work for a used model, registered in the past. But "you can also estimate the future residual value that a car will retain after six months, one year, five years... with different combinations of time and mileage."

Its impact is wide-ranging. In a VN, it will determine the amount we receive if we trade in a used car. And if the transaction is financed, it will influence the monthly payment based on the risk assumed by the financial institution in the event of default. If it's a flexible purchase, it establishes the final payment, which is the minimum guaranteed buyback value or the amount we'll have to pay to keep the vehicle. Similarly, it's essential in leasing to calculate the monthly payment, as we mentioned earlier. "Last but not least, it's necessary for insurers to measure risk and set premiums, since the car's depreciation over its useful life helps measure the cost of compensation in the event of an accident."

HOW IS IT OBTAINED?

To calculate this element, up to 25 variables are analyzed. For example, in used car models, Eurotax collects market information, data from dealers, car dealerships, websites, and other professionals. "We clean and statistically process this information, and each month it is updated based on market movements. In short, a car's residual value is a reflection of its average transaction price."

The process, Azofra says, becomes less straightforward when it comes to "estimating the future value of a product or model over its useful life," as is the case with leasing . More factors come into play here. "On the one hand, you always have to give great weight to the performance of that model or brand in the secondhand market; whether it's in high demand; greater or lesser pressure on prices; how its competitors are performing; the brand's promotional activity, etc."

From there, the technical and equipment features are assessed; the technologies; what new features it offers compared to its rivals; its expected life cycle (the time it will last as a new car); its price positioning; and, of course, the exterior and interior design and the quality of the materials.

Trends and macro variables

Furthermore, the expert assures that "current automotive trends, the demand for different engines or body styles, and their evolution are also important ." Hence, a hybrid SUV is a much safer bet today than a diesel sedan. Although both will have their audiences.

Finally, macroeconomic variables must be considered. These include inflation, consumer confidence, the unemployment rate, and interest rates. "They are very important in estimating future prices, as they will affect the health of the economy and the pocketbooks of future buyers."

But one wonders how the market value of a brand with little history, such as the Chinese brands that have recently arrived in Spain, is estimated .

30 YEARS DATA

"We're talking about time series here. Eurotax has over 30 years of historical data. We know how the used market behaves in any given scenario or economic situation, and how similar makes and models, engine technologies, segments, and different body styles typically depreciate. Ultimately, we have many current 'snapshots' that help us map out the future scenario for each make or model."

In the case of very new brands with no experience in the used market, such as Chinese brands, "the competitive environment is analyzed; their price positioning and demand sensitivity; the length of their warranty; their capillarity in terms of points of sale and workshops; the availability of spare parts, including the expected volume and through which channels." For all these reasons, it is essential to understand the detailed landing strategy of these manufacturers.

speed of the Chinese

In general, a brand needs time to consolidate its residual value, as the initial offering usually involves gaining volume through discounts and very competitive prices. "It's necessary to gain ground in the used car segment before generating interest in used cars," says the expert, who also points out that " the production cycle of Chinese cars is very different from that of European, Korean, or Japanese cars." Their brands are very quick to introduce new models and improve them, which inevitably ages previous models and reduces their residual value.

In a sense, it's somewhat the opposite of what happens with premium models , which have traditionally stood the test of time best. "Their cars depreciate less thanks to less risky designs and fewer generation gaps, so they still look young and maintain interest."

The impact of hybrids

Although Azofra points out that Dacia has also been a leader in residual value (in percentage terms) for many years. Its fair price policy without discounts, with a clear focus on the consumer market, and a good price and equipment mix, has allowed it to retain a significant portion of its value over time.

But in the last two years, he says, "the situation has changed radically." Driven by CO2 reduction policies, demand for new and used cars has shifted toward more efficient engines. And as electric vehicles are becoming more widespread in Spain more slowly, interest has focused on hybrids. "This interest translates into a high transaction value, without pressure or the need for promotional activity, and the best turnover figures (fewer days to sell). Although several brands offer hybrids, Toyota is the most established in this technology and, therefore, the leading brand in residual value today."

Recent years

There have also been developments in the evolution of residual values. "Until the pandemic, they were moderately stable, with very slight upward or downward trends that continued over several years," he begins his analysis.

"After the lockdown, prices fell for two or three months due to the need to get rid of stock and relieve cash flow. From then on, the opposite effect occurred; they began to rise significantly, first due to the interest in individual mobility; and then due to more structural problems such as the component and supply crisis, which shifted demand to the used market; the war in Ukraine, which affected several manufacturers and made component prices more expensive; the extension of leasing contracts; the inability of rental companies to renew their fleets, etc."

Spain resists

The result was that a used car cost 24% more at the end of 2022 than at the beginning of 2020.

Today, "prices remain above pre-pandemic levels, although they are gradually adjusting toward more reasonable levels. In neighboring countries, the declines are more pronounced, but the good economic situation has made Spain very resilient in terms of residual values, with a dynamic, and increasingly professional, sustainable, and balanced second-hand market."