The 2004-model vehicles, and some 2005 models, you acquired will most likely be taken out of service for resale in the 2007-calendar year. If predictions hold true, used-vehicle prices will begin to decline at that time, according to Automotive Lease Guide (ALG), a provider of residual value projections. ALG forecasts used-vehicle prices rising about 1 percent in the next two years and then start to decline in 2007. In particular, ALG forecasts that mid-size cars, full-size SUVs, and minivans will decline at a faster rate than the industry average.

There are two reasons for this impending decline in resale values. First, is that the aggressive new-vehicle incentives that auto manufacturers are using to stimulate retail sales are predicted to continue in future model-years. In fact, ALG predicts that net new-vehicle prices will continue to decline at a steady 1-2 percent rate for the next 4-5 years. These incentives will continue to exert downward pressure on used-vehicle prices.

The other factor that will impact used-vehicle prices in 2007 and later years is the anticipated increase in the inventory of used vehicles in the wholesale market, causing a supply-and-demand imbalance. New-vehicle production levels are predicted to increase from 16.8 million in 2004 to 18 million by 2007; much of the increase will be retail leased units, which are remarketed in the wholesale market.

Adjusting Your Amortization Rate
In the commercial fleet market, the most common amortization rate used for establishing a depreciation reserve is 50 months. At this rate, the original value of a vehicle is reduced to zero over the 50-month term. Each month, 2 percent of the capitalized cost is placed into a reserve for depreciation. The goal is to reduce the original value of the vehicle on the company’s books so that its unamortized book value will approximate its resale proceeds. However, for the past several years, 2-percent monthly depreciation has often not been sufficient, causing anguish for many fleet managers.

In the real world, the process of establishing a depreciation reserve rate is often complex, and other factors come into play. For instance, when vehicles are funded under a TRAC lease, the rate of depreciation is sometimes calculated by a lessor to make the monthly lease payment market competitive, or a lower rate of depreciation may be requested by the lessee to lower monthly payments. Either way, this invariably results in deficiencies at end of a vehicle’s service life.

Since a fleet is comprised of different vehicle segments, a fleet manager should give consideration to establishing multiple amortization rates based on different fleet applications or for vehicles used in different geographic terrains. You should try to match the depreciation reserve of these vehicles as closely as possible to their historical depreciation. Sometimes, to protect against large deficiencies on resale, amortization rates are set higher than necessary, resulting in resale proceeds that are higher than the book value. However, you should avoid “over-amortization.” This unnecessarily ties up corporate capital that could be used for other income-producing ventures.

Not All Incentives are Bad
There are two ways to lower vehicle net depreciation: increase resale value or decrease net acquisition cost. Aggressive fleet incentives, as opposed to retail incentives, help to lower net acquisition cost, which ultimately lowers net depreciation. A number of fleets have chosen to capitalize rifleshot incentives into the cost of the vehicle to reduce acquisition cost. However, fleets that chose to take these incentive monies in the form of a check are continuing to struggle to recoup enough at resale to break even, especially if they are depreciating vehicles at 2 percent per month. Compounding this problem is that some fleet managers receive a bonus that is dependent on the size of the rebate check they are able to negotiate. Although it may be rewarding to wave a fat rebate check before your management, it is far less rewarding to have to explain why your company has to pay for a residual deficiency.

Let me know what you think.

mike.antich@bobit.com