By Marc Stengel

SEPTEMBER 28, 1998:  Some people buy used cars on principle. They don't believe in taking a depreciation hit the moment they drive off the new-car lot. Other people buy used cars out of prudence. They're the ones who prefer to pay cash for a six-year-old car, then laugh all the way to the bank about the financing costs they've avoided. The really interesting folks, though, are the ones who buy used cars for the sheer gamesmanship of it all. These are the people who view every used-car transaction as a way to match wits with used-car sellers. Buyers of this propensity, therefore, are always looking for a secret weapon that will allow them to gain the upper hand, however briefly.

By a curious twist of fate, not to mention turn of the business cycle, a rare and probably perishable secret weapon has materialized in 1998. Buyers aware of the concept of "upside-down residuals" are suddenly armed with a powerful tool for identifying hidden values in certain used cars, and then negotiating for attractive, low sales prices. Although not widely known outside the auto-dealership and vehicle-financing businesses, "upside-down" car values are neither hard to understand nor especially difficult to identify.

Let's take a quickie-course in auto leasing, shall we? Usually, people think they're merely "renting" a car when they enter a lease agreement with a dealer. In truth, they're actually acquiring temporary use of the vehicle--say for two years--in return for financing the difference between the new car's sticker price and its lower, presumed price at the end of those two years. This post-lease price is called the "residual," and the dealers or lenders who lease cars can essentially fix the value at whatever level they choose.

This is not to say that the residual a dealer chooses will necessarily reflect fair-market value when the customer's lease expires. In fact, quite the contrary is true lately. Many cars coming off lease this year are being valued at prices well below the residual values stipulated in their lease contracts. These are known as "upside-down" deals--arrangements that virtually guarantee a money loss for the auto dealer or financing company that leased the car in the first place. In the cruel fairness of the marketplace, however, an upside-down deal is one that a savvy shopper can exploit to his or her financial advantage.

In a nutshell, there's a rash of upside-down deals in the leasing market because dealers and leasing companies artificially inflated future residual values several years ago. This tactic has the effect of reducing lease payments, because the driver is financing a smaller difference between the sticker and the inflated residual. This is one of the reasons why new-car leases have become so incredibly popular over the past several years. But just ask dealers and lenders if they're so happy about all these overvalued leases coming back home to roost. Although lessors have the opportunity to buy an "off-lease" vehicle for its stated residual, too many folks lately are saying, "No thanks." That's because the actual market value of the car is less than the residual, and nobody in his right mind would willingly overpay. As a result, the dealer is left holding a bunch of cars that are almost guaranteed to sell at a loss.

On March 23, 1998, the trade publication Automotive News published a brief summary of makes and models that have typically been overvalued by leasing companies. Predictably, the list was full of SUVs and high-end luxury models; but there were also some good buying opportunities for lovers of sporty compacts. Both Acura and Saturn were plagued with upside-down residuals for all models in their respective lines. The Ford Probe made the list (although, curiously, Mazda's 626 did not); Pontiac's Grand Am and the Dodge/Plymouth Neon were named as well. In fact, Automotive News reported that "about 40 percent of the models coming off two-year leases in July 1998 [were expected to be] upside-down, according to Automotive Lease Guide." These are the vehicles that represent the best used-car values for shrewd customers who do their research.

Just as the NADA "Yellow" Book and Kelley Blue Book are bibles of the used-car trade, the Automotive Lease Guide or ALG is the equivalent for leased vehicle values. ALG's info is specifically targeted at dealers and represents "best guesses" of the future values of vehicles from one to five years down the road. Because ALG has observed that dealers and lenders are inflating the published residuals "by as much as 6 to 8 percent of suggested retail," these cars are likely to come "off lease" with unrealistically high prices. In other words, the people who've been leasing them won't want to buy them at the end of the lease; and dealers, in turn, will be eager to sell them for the best offers that come along.

Identifying such buys, of course, is an inexact science, but sometimes just being aware of the issue can provide crucial leverage during hard bargaining. Moreover, it doesn't really matter if the exact car you're researching was actually leased or not, since the inflated residual value indirectly affects the market price of every model in the same line. Ideally, for example, you'd want to know what ALG predicted two years ago would be the residual value of a car coming off of a two-year lease today. How that number compares with the current wholesale prices published in such guides as the Yellow and Blue books--not to mention the actual sticker price of the car on the lot--will tell you a lot about whether its value is potentially upside-down. And when a deal is upside-down for the seller, it just may be right-side-up for you.

Time is money

To learn more about the Automotive Lease Guide, contact the publisher by mail at 2034 De La Vina St., Santa Barbara, CA 93105; by fax at (805) 898-3733; or by phone at (805) 563-0777.

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