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New and used car prices in the US are hitting record highs and show no signs of slowing down. While customer appetite for cars continues to grow, tight inventories and tangled supply chains are making it difficult for car companies to keep up with demand.
New car prices have soared 20% over the past year in the US, while the nation’s economy continues to struggle due to the turmoil caused by the COVID-19 pandemic. The worldwide shortage of microchips has slowed down the production of new cars, and even used ones are available at a high price. As travel increases, car rental companies are struggling to meet infuriating demand, having sold most of their vehicles on the used car market in 2020 to survive during tough times. An extremely low interest rate on car loans offered by companies adds to the high demand for cars in the US, where car loans account for 9.5% of US debt, second only to mortgage and student loans. Therefore, strong customer appetite for new cars, fewer vehicles on dealer lots, tight inventories have resulted in an average transaction price increase. Additionally, tangled supply chains make it difficult for companies to keep up with demand. New car prices could rise further as the global shortage of semiconductor manufacturing appears to be worsening due to increased demand for electronics.
Car prices outperform headline consumer inflation
The median price of new cars reached an all-time high of $38,255 in May 2021, an increase of around 12% from the same period a year earlier. Wholesale prices for used cars sold at auction have risen 39%, while retail prices for used cars have risen. It’s up 20% from last year. Prices have reached the highest levels they have ever been and continue to accelerate rapidly, thereby raising the nation’s overall inflation rate. In 2020, many car dealerships closed due to a 30% drop in sales in the second quarter, the biggest quarterly drop since the Great Recession. However, strong demand for cars has led to price increases at the fastest pace in more than 13 years, with used car prices accounting for an overall increase of 5% in May 2021.
• Inventory shortage
The resurgence in car demand comes at a time when many new car production facilities have closed due to a global shortage of microchips. According to an investigation by cox Automotive, New car production in North America fell to about 3.4 million vehicles in the first quarter of 2021. 53% of automakers source their microchips outside the country, and the US-China trade war adds to the shortage of semiconductors, which has become the biggest hit to supply. 38% of production facilities temporarily halted vehicle manufacturing due to a disruption in the supply of microchips. The shortage resulted in about USD110 billion revenue losses for the automotive industry. The global microchip crisis is expected to affect the auto sector for at least the next six months, even as efforts are under way to increase domestic semiconductor production with proposed new plants. Additionally, a shortage of used inventory due to fewer repossessions is driving up new car prices. Shrinking inventories are making distributors work harder as wholesale prices appreciate much faster than retail prices, thus shrinking margins at a rapid rate. While smaller distributors manage to make more margin on wholesale inventory than retail, larger distributors make up the difference with volume.
• Fewer car repossessions
Gone are the days of used vehicles being dumped in junkyards when they got over 100,000 miles. The average age of vehicles has risen to 12.1 years, compared to 11.9 years in 2020, reflecting their higher value. According to Manheim Used Vehicle Value Index, the average price of a used vehicle in May 2021 reached USD 20,426, 46.7% more than in 2020. Factors such as the introduction of newer and safer technologies, greater reliability, better quality of cars and a increased longevity are increasing the value of used cars. However, used cars are in short supply due to the effect of the pandemic on car rental companies. Due to declining demand during the pandemic due to travel bans and repeated lockdown restrictions, car rental companies have sold parts of their fleet without buying replacements to counter cash shortages. With fewer people renting cars, rental car companies and other fleet buyers aren’t dumping as many old or buying as many new vehicles, driving up prices. Additionally, increased competition for used vehicles, especially from online car sellers like Carvana and Vroom, due to high bidding wars at auction, is driving up car prices as much as new.
• Stay away from the cheapest cars
Even before the pandemic hit, many automakers began replacing lower-priced vehicles that provide low profit margins, like sedans and hatchbacks, with SUVs with relatively higher sticker prices. The growing consumer shift from less expensive sedans to more expensive SUVs and trucks is gathering momentum. The auto industry in the US has been abandoning the production and sale of cars below the $30,000 price point, giving up low car price territory to the used car market. Many automakers are cutting production of less popular models in response to a global shortage of microchips to meet consumer demand for new models. Furthermore, next-generation technologies and green models are attracting customers and rapidly changing their buying behaviors. Some consumers are ready to splurge more on high-trim vehicles, including premium finishes, high-tech features and performance upgrades, all of which contribute to higher prices.
• More cash available
When the pandemic hit, many shoppers weren’t spending on restaurants or vacations, so now they’re choosing to use the money saved on loaded trucks or SUVs, expanding their car spending more than they otherwise would have. According to Moody’s Analytics, Americans now have an additional $2.4 trillion in savings compared to last year due to repeated economic setbacks. Additionally, government stimulus checks are helping buyers use the money to make down payments and select the vehicles of their choice. Low interest rates are putting vehicles within the reach of many buyers, which has spurred demand for new vehicles in the $50,000 and up range. Therefore, the greater inclination of customers for high-priced vehicles is contributing to the average price of cars. In addition, reduced mortgage payments are allowing buyers to fit their car payments into budget that previously would not have been possible.
• Opening of Commercial Premises
In 2020, many workplaces asked their employees to work from home as an effective measure to reduce the spread of the coronavirus without hindering work. However, as offices reopen with ease due to lockdown restrictions and rapid vaccination drives, people are returning to work, further fueling demand for cars. The new generation of employment added to the reopening of commercial spaces adds to the demand for car purchases. Additionally, people who used to prefer public transportation are now turning to car travel to reduce exposure to COVID-19. Thus, the strong demand for cars due to the unlocking measures is driving up vehicle prices.
How do rising car prices affect the average American?
While rising auto prices bode well for the nation’s economy, many consumers are struggling to afford new or used vehicles. Nearly 64% of Americans commute, and those who rely on cars for transportation are forced to take out long-term auto loans to purchase a new car, which could keep the owner in debt for years to come. When buyers invest equity in a new car, they are paying for a depreciating asset, as average car prices drop more than 20% as soon as one rolls off the dealer lot. Car prices can drop by close to 90% after two decades, meaning that no matter how much money the buyer spends on the new car, they will only earn a fraction while selling it.
According to the New York Federal Reserve, more than seven million Americans are nearly 90 days behind on their auto loans, and delinquency rates among borrowers with the lowest credit rates are rising. Rising used car prices are adding salt to the wounds of poor Americans struggling to make ends meet without an affordable transportation solution.
Supply chain shortages are hurting automakers’ bottom lines. For example, the microchip shortage is expected to cost Ford and General Motors around $1 billion in profits in 2021. Yet dealers are the real winners from rising car prices, whose profits have been tripled since 2020. Now is the perfect time to be a car dealer as demand is incredibly strong. However, price-sensitive buyers face a tough market. If price becomes the main driver, shoppers could focus on market segments where they could find better deals and healthier inventories. While many economists believe that inflation is temporary, the uncertain economic outlook is huge due to rising consumer savings and government payments while supply chains are disrupted.
According to TechSci’s research report on the “U.S. Used Car Market by Vehicle Type (Small Cars, Undersized Cars, and Luxury Cars), by Sector (Organized vs. Semi-Organized/Unorganized) , by Fuel Type (Gasoline, Diesel & CNG), Competition, Forecast & Opportunities, 2026”, US used car market expected to grow at formidable CAGR of 8% due to increasing proliferation from websites that sell used cars and discounts on aftermarket services or insurance offered by used car dealers. In addition, high new car interest rates and soaring new vehicle prices are expected to drive the growth of the US used car market during the forecast period.