Switch to electric cars held back by expensive leasing contracts

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To become mainstream, electric cars must first become affordable.

Dozens of countries, from the UK to France and Norway, plan to phase out the sale of motor cars by 2040 or earlier.

But their replacements, largely battery electric vehicles, remain stubbornly expensive.

There’s “just this huge divide between those who can afford an electric car and those who can’t,” said Meryem Brassington of Lloyds Banking Group, the UK’s biggest car lender.

This is not only due to expensive battery technology, but also to the reluctance of banks to make leasing contracts cheaper.

These agreements dominate the market. In the UK, nine out of 10 new cars are bought under a financial lease or similar arrangement.

Before financiers determine what to charge motorists under a lease contract, they must calculate a car’s residual value – the projected value of the vehicle in three or four years from the end of the contract. .

Problems with calculating residual values, or future used prices, are partly responsible for keeping electric leasing prices high.

This is because there is little data on which to base them, unlike combustion engine vehicles, where dealerships use mileage and service history in an established market to give a car future used value. .

This system meant that instead of paying directly, most buyers of combustion engine cars in Europe bought them on credit in a deal based on its expected devaluation.

For example, if a £35,000 car loses £12,000 in value over three years, the buyer only has to finance that £12,000 rather than the full cost of the vehicle. This means that a car that depreciates less has a higher residual value and a lower monthly lease payment.

The trend has been key to the growth of premium brands such as BMW and Mercedes, whose vehicles are becoming more affordable because they retain their value better than mass-market nameplates.

Reducing the depreciation of electric vehicles is therefore essential to make the predominantly expensive battery-powered cars more accessible to consumers.

A Volkswagen ID.3, which went on sale in 2019, is starting to sell on the second-hand market, allowing financiers to assess the condition of their battery © Sean Gallup/Getty Images

At the center of the equation is the battery.

“Remember that the battery is the biggest asset to improving the residual value of the car,” said Ashwani Gupta, chief operating officer at Nissan.

“When you look at customers driving [the electric] Leaf since 2010, and when we check the battery status, even after years, we get a range between 85% and 90%,” he told the Financial Times’ Future of the Car Summit in May.

An important benefit of electric vehicles that helps them retain their value is fewer moving parts, and therefore lower maintenance costs.

“Usually there’s not much to replace, there’s less maintenance compared to combustion engine vehicles,” said Simon Engelke, founder of Battery Associates, a consultancy group that runs courses. battery vehicle training for industry executives.

Rental group Hertz, which recently started including electric models from Tesla and Polestar in its fleet, said last month that its maintenance costs on the cars were around 50-60% of what they were spending on the cars. motor cars, with “slightly higher” expenses. additional tires as vehicles tend to be heavier.

“We find that the depreciation rate of the EV is lower than [internal combustion engine] vehicles,” Chief Financial Officer Kenny Cheung told investors.

The big question is why the growing awareness of battery longevity doesn’t immediately translate into lower rental prices for electric vehicles, which remain stubbornly expensive.

The main reason for this is the reluctance of the banks, which are behind these write-down agreements, to cut costs. With the small amount of data to calculate the future values ​​of electric cars, or residual values, they have resisted lowering rental rates.

Mike Todd, the head of VW’s UK financial services arm, said there was relatively little data available on used battery cars.

“I could share data on hundreds of thousands of gasoline and diesel cars, but we have a much smaller sample for electric vehicles,” he said.

Still, sample sizes are increasing as the first latest-generation EVs, such as VW’s ID.3 that went on sale in 2019, begin to sell on the second-hand market, allowing financiers to assess their battery status.

“The prices they [the ID.3s] the recovery is encouraging and goes into the residual values ​​reset today,” he said.

However, one factor that could lead to greater depreciation of electric vehicles, Todd added, is the steady advances in battery technology, which means older models may prove harder to sell.

A Hertz Tesla electric car on display during the Hertz Corporation IPO at the Nasdaq Market site in Times Square in New York in November 2021
Hertz now includes Tesla cars in its fleet © Brendan McDermid/Reuters

“If you take a gasoline vehicle sold new today, the technology in three years will not be that different from the gasoline vehicle of today,” he said, adding that in three years the improving the range or efficiency of a new EV car can make older models less appealing in comparison.

Ultimately, it will take time – Todd counts three to four years – for enough data to accumulate to convince financiers to take the plunge and increase the residual values ​​of electric vehicles, which in turn will reduce rental rates.

“Then we will have enough information to be sure of the [residual value] setting,” he said.

Many of these automaker-owned “captive finance” companies, such as VW Financial Service or Ford Credit, are also major profit drivers for their parent companies. The VW branch made a profit of 3 billion euros in the first half of this year, while Ford made $1.7 billion.

This has led some industry players to argue that lenders have at least some incentive not to push the switch to electric vehicles, which will lead to lower short-term profits, faster than necessary.

This has caused the emergence of a new wave of small electric-only rental companies, which aim to exploit what they perceive as a market gap.

“The market is still relatively conservative on [second-hand values]said Fiona Howarth, Managing Director of Octopus EV, an electric car rental arm of Octopus Energy which operates in the UK and US.

“But they don’t feel comfortable taking that step. If you were willing to be braver and set residuals solidly, it would lower the monthly price.

Besides lowering maintenance bills, the ironclad rules of supply and demand will also bolster used car residual values, Howarth predicts.

“There were 200,000 new electric cars in the UK last year, they won’t hit the second hand market for another three years,” she said. By then, the number of people looking for used electric vehicles will be so high that available cars “won’t even touch the side” of the level of demand, she added.

In the past month alone, there were more than 5 million views on AutoTrader of used electric car ads, according to the online marketplace.

While EVs that have a better value can be good news for first-time buyers who reap the benefits of lower monthly payments, it means the cars will be more expensive when they hit the used market.

This is likely to push second-hand buyers, who primarily use cash or bank loans rather than amortization-based financing arrangements, towards leasing.

“We are seeing significant growth in used car financing,” said Todd of VW Financial Services. He estimates that around half of the used cars VW sells are financed, up from 35% “a few years ago”.

Additionally, the used value of vehicles, the factor that will determine how much used buyers pay on a monthly lease, is much less certain. The data pool for cars over six years old is even shallower.

“We don’t know how much it’s going to be worth five or six years out,” Todd said, “so the idea that residual value risk is hedged might also be a factor.”

Many manufacturers, aware of this, now offer a warranty on the battery that lasts eight years.

But consumers still want certainty – and are willing to pay for it.

In one example, US consumers paid $2,000 more for an electric vehicle with a battery health certificate than one without, said Patrick Cresswell, chief executive of consultancy Future Motion.

He added: “One of the key pillars is to make used electric vehicles an attractive thing that people can buy with confidence.”

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