How are Car Lease Residual Values Determined?

This may possibly be more than you need to know about lease residuals, but if you’re curious you might find this of interest.

About Residuals

If there is a “black art” in car leasing, it’s in the process of creating residual values. Attempting to predict future values of automobiles in the face of changes in manufacturers’ product lines, model upgrades, price increases, vehicle reliability histories, recall events, supply-and-demand dynamics, and national economic uncertainty is a very complex and risk-ridden task for lease companies.

Lease finance companies are caught between two conflicting objectives: setting residuals high enough to make their leases attractive and competitive, and keeping the same residuals low enough to insure that the company will make money and won’t be stuck with overvalued vehicles when customers return them in a few years. It’s a betting game.

Many of these companies can suffer from overly ambitious vehicle residuals set during years when the U.S. economy is healthy. If the economy turns sour during the time those leased vehicles are being returned, the actual values of the vehicles will be less than the projected values.

As a result, car companies not only lose money during the lease (payments are too low, based on an unrealistically high residual), but also lose again when they sell the returned vehicles.

Setting Residuals

Lease finance companies set residuals by looking at how used-vehicle resale values have held up the last few years, as measured by wholesale auction prices and trade-in values.

But this is like attempting to predict this year’s stock prices based on last year’s performance, or forecasting next month’s weather based on what happened this month. It’s just educated guessing, nothing more, but with serious consequences for the leasing business betting on the outcome.

There are also other factors that complicate the process of predicting residuals. Because of the large number of combinations of vehicle makes, models, trim packages, and options — all of which affect residuals in different ways — it’s nearly impossible to accurately account for every permutation.

Residuals are not perfect

Leasing companies generally compromise by selecting the most popular vehicle configurations to base their residuals on. When brand new makes/models are introduced, it’s even more difficult because there’s no previous history to look at, so residuals are based on similar makes/models that have been around for a while. Obviously, this is not very accurate, but it’s the best that can be done.

Residuals are typically expressed as a percentage of MSRP (list price), assuming “normal” mileage (typically 10,000 to 15,000 miles per year), good return condition, and a “typical” configuration of options.

Dealers and their associated leasing companies use residual “books” that are frequently updated with the latest percentages, as determined by the leasing company.

Residuals are frequently boosted temporarily for limited-time promotions and special lease deals

Different leasing companies will almost certainly have different percentages for exactly the same vehicle, depending on how aggressive or conservative they want to be — and how good their prediction data are. Car manufacturers set their own residuals as they see fit. Setting high residuals is one way they can be competitive and lease more cars — at the risk of losing money when the cars are returned at lease-end.

We provide average lease residuals in the Residuals Calculator in our Lease Kit.  Our average values allow you to evaluate actual residual values you might receive from a car dealer. If the value you receive is less than our average, it’s not a good deal. If more, then your higher-than-average value is a good deal.

Effect of residuals on lease deals

Consumers benefit from high residuals. The higher the residual, the less the lease cost. If residuals are set artificially high by the lease company, they take a financial hit when the car is returned. The consumer returns the car and walks away pleased in knowing they paid less than they should have for the lease.

If you know that you will purchase your car at the end of your lease, it’s better to have a lower residual — which lowers your lease-end purchase price. Having said the above, lease residuals are not negotiable and customers have no control except to shop at different dealers who might have different residual values for the car you want. This is more likely to happen with American car brands than with foreign brands.

Video Explaining Car Lease Residual Value

Summary

In summary, just remember that residuals are nothing more than educated guesses based on historical vehicle data and economic predictions. The guesses are nearly always different, depending on who’s doing the guessing.

Sometimes the guesses turn out to be right, but are frequently wrong. Incorrect guesses sometimes benefit you and me; sometimes they benefit the leasing company.

And so that’s the way it is with leasing residuals.