By Alysha Webb, Editor and Publisher
The Federal Reserve last December increased its target interest rate by 25 basis points. In March, it once again boosted the rate by 25 bps. Money is a bit more expensive now, and dealerships will start to feel the pinch in their bottom lines.
As rates slowly rise, consumers will begin to adjust their buying behavior, which means slower sales in an already cooling car market. That will mean the end of cheap money for acquiring dealerships, say experts.
“Lenders love car dealers,” James Taylor, managing director at The Presidio Group, tells Automotive Buy Sell Report. “But they are still commercial lenders [and] they work on a spread. Any types of constraints on new car volume – which is revenue generation – then lending will start to be constrained.”
The buy sell market is healthy right now, but part of that is attributable to the very low interest rates, says Taylor. The Presidio Group is busy. “Values are stout,” says Taylor. Buyers are still “paying up” for what they want, he says. “Money is cheap.”
Consumers’ car-buying behavior is unlikely to be impacted in the near term by the interest rate rise. Rates are still very low. And manufacturers and dealers will offset the higher interest rates with sales incentives. Rising rates are a sign of a healthier economy, points out Blake Seabaugh, CPA and tax manager at Perkins & Co., an accounting firm in Portland, Ore.
But the rising rate environment “will play into investor’s analysis on: cash-on-cash returns, leveragability, goodwill multiples, overall deal financing, and will put downward pressure on real estate values in certain markets,” he tells Automotive Buy Sell Report.
A healthier economy could also mean the days of floorplan assistance profit centers for dealers are “coming to an end,” says Seabaugh.
There is a question of just how healthy the retail car market is, of course. True, transaction prices continue to rise, up two percent in March compared to the same month in 2016, according to Kelley Blue Book. The average new light vehicle now costs $34,666 says KBB.
But actual sales have plateaued. The March SAAR, at around 16.5 million units, was below 17.5 million, the rate analysts polled by news agency Reuters expected.
Meanwhile, consumer’s wallets will start to be squeezed by the rising rates, says Seabaugh. That means dealers will have to work harder to move vehicles. At the same time, the cost of holding inventory – floor planning – will be on the rise, as well. That will create winners and losers among dealership, he predicts.
“Attractive leases, longer loan terms, and mid-tier trim levels will make deals happen,” says Seabaugh. “Faster turns is the name of the game when inventory holding costs increase.”
The 200 bps tipping point
The Fed’s target rate is currently a far-from-onerous 0.75 to one percent.
But assuming the economy stays healthy, the Fed has indicated it will continue to raise interest rates through 2019. When interest rate increases reach 200 basis points, or two percentage points – the inflection point in both dealership valuation and consumer is reached, says Taylor.
That will result in a 20 percent reduction in today’s Blue Sky values, he says. At new car franchises, used car sales will increase. There is also an increase in parts and service income in a rising interest rate environment, he says. “But there will be a slowdown in new car sales.
Two hundred basis points is “a tipping point in consumer behavior,” says Taylor. “Consumers start to feel the bite.”
He adds: “We haven’t modeled that in yet.”