How is Inflating Lease Residuals Dangerous?

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Toyota may be inflating residuals for their new vehicles to boost sales.

Inflating residuals can be “risky”, as these cars could cost automakers millions of dollars when they are sold.

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Toyota is reckless

This whole train of thought is, at best, exaggerated worry to me. Here are the reasons why inflated residuals don’t matter.

Let’s first understand that there are only three options to make a lease less expensive. There are three ways to make a lease cheaper: reduce the upfront cost, lower the interest rate or increase the residual value.

Leasing cash can be a quick and simple way to reduce upfront costs, but it can also damage resale values.

Leasing costs can be reduced by lowering interest rates, but only if the rate reduction is significant. The rates are already so low that it makes no difference to reduce them.

The residual value can be increased (or decreased) by the leasing company, which will reduce their monthly payment. Problem is that the inflated residual value will “come home” in 2 to 3 years. At this point, the leasing company will own a car worth more than it is worth.

Automotive News says that the last option is risky. It’s not. It’s not more risky than leasing in general. Toyota, and many other automakers, could be left with thousands of unpaid lease returns.

This is a risk that every automaker faces when leasing a vehicle. It’s not relevant. These are risks that can be associated with inflating residual lease payments, and not financial calamity.

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Calculate it Out if in Doubt

Let’s say we want to boost Toyota Camry sales by offering a lease program. Let’s assume we have decided to increase 3 year residuals by a staggering 5%, from 53% to 58%.

  • If we assume an average MSRP value of $24,000, our average residual increase is $1,200 (5 % of the MSRP).
  • Old residual = $24,000 MSRP *53% = $12,000.
  • New residual = $24,000 MSRP *58% = $13,920

It is doubtful that any journalist covering this story did this basic math. They would have noticed that a $1200 inflated residual on a Camry seems a lot like a cash incentive. This is the kind Ford, GM and Chrysler-Fiat offer every day on their cars. No big deal.

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To be complete, however, you should consider:

It is possible that the $1,200 residual was not exaggerated. A Camry 3 years old could be worth $14k. With inflation and expected price increases for new vehicles in 2016, and a hopefully booming economy, used vehicle prices could continue climbing.

Toyota still has the money they need today, even though the $1,200 bill won’t be due for three years. Toyota can save some of their sales revenue today to pay the residual in the near future. They can also earn a return while they wait.

Some vehicles are not returned. A good number of cars that you lease (between 20-30%) will be purchased by the owner. These people will either trade in their Camry to buy another car or decide to keep driving the Camry until the lease ends. A good number of vehicles with inflated residuals are safe.

Last but not least, Toyota can help to soften the blow by supporting the used car market. Let’s suppose that every Camry, or Corolla, returned is bought for $1200 more than it was worth. Toyota can encourage dealers to purchase the lease returns at full price by waiving vehicle certification fees or providing certified Toyota consumers with special interest rates (like 1.9%).

Toyota, Ford, and others are all examples of companies that “promote the used vehicle market”. It’s something they have done for many years. It’s the reason certified used vehicle programs exist. The automaker supports used vehicle sales to increase residual values, grow the brand’s reach, and, most importantly, support additional new vehicle leasing. ;

All of these things combined, the risks are pretty low, don’t they?

Summarising, if someone puts the words “risky”, “Toyota”, in the same headline they are probably wrong. Toyota is as risk-averse and as smart as it gets. Inflating residuals is just another way to spend incentive money.

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