Switch to electric cars held back by costly leasing deals

To become mainstream, electric cars first have to become affordable.

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

But their replacements, largely battery-powered electric vehicles, remain stubbornly pricey.

There is “just this huge gap between those who can afford an electric car and those who can’t”, said Meryem Brassington from Lloyds Banking Group, the UK’s largest auto lender.

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This is not just down to the costly battery technology, but also the reticence of banks to make leasing deals cheaper.

These deals dominate the market. In the UK, nine out of 10 new cars are bought using a lease or similar agreement.

Before financiers work out what to charge motorists in a leasing deal, they have to calculate the residual value of a car — the vehicle’s projected value in three or four years’ time when the agreement ends.

Problems calculating residual values, or future second-hand prices, are partly responsible for keeping electric leasing prices high.

This is because there is little data to base them on, in contrast to combustion engine vehicles, where dealers use mileage and service history in a well-established market to give a car a future second-hand value.

This system meant that rather than paying outright, most buyers of combustion engine cars in Europe bought them using credit through a deal based on its expected devaluation.

For instance, if a £35,000 car loses £12,000 of value over three years, the buyer only has to finance that £12,000 rather than the total outright cost of the vehicle. This means 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 become more affordable because they hold their value better than mass market nameplates.

Reducing the amount that electric vehicles depreciate is therefore key to making predominantly expensive battery cars more accessible to consumers.

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

At the centre of the equation sits the battery.

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

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

One significant advantage of electric vehicles that helps them hold their value is fewer moving parts, and so lower maintenance costs.

“Usually, there is 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 battery vehicle education courses for industry executives.

Rental group Hertz, which recently began including electric models from Tesla and Polestar in its fleet, said last month its maintenance costs on the cars are roughly 50-60 per cent of what they spend on engine cars, with a “slightly higher” spending on extra tyres because the vehicles tend to be heavier.

“We are seeing the depreciation rate on the EV being lower than [internal combustion engine] vehicles,” chief financial officer Kenny Cheung told investors.

The big question is why growing awareness of battery longevity is not translating immediately into lower lease prices for electric vehicles, which remain stubbornly expensive.

The chief reason for this is the reluctance of banks, which sit behind these depreciation deals, to lower costs. With the small amount of data to work out future electric car values, or residual values, they have resisted dropping leasing rates.

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

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

Yet, sample sizes are growing as the first in the later generation of electric vehicles, such as VW’s ID.3 that went on sale in 2019, are starting to sell in the second-hand market, allowing financiers to gauge their battery health.

“The prices they [the ID.3s] are fetching is encouraging and is going into resetting of residual values today,” he said.

However, a factor that could lead to greater depreciation of electric vehicles, Todd added, are constant 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 City in November 2021
Hertz now includes Tesla cars in its fleet © Brendan McDermid/Reuters

“If you take a petrol vehicle today sold new, the technology in three years’ time will not be that different to the petrol vehicle of today,” he said, adding that in three years’ time, the improved range or efficiency in a new EV car may make older models look less attractive by comparison.

Ultimately, it will take time — Todd reckons three to four years — for enough data to build up to convince financiers to take the jump and increase the residual values of EVs, which in turn will lower leasing rates.

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

Many of these “captive finance” companies that are owned by the carmaker, such as VW Financial Service or Ford Credit, are also large profit drivers for their parent companies. VW’s arm made €3bn profit in the first half of this year, while Ford made $1.7bn. 

This has led some in the industry to argue that the lenders have at least some incentive not to push the electric vehicle shift, which will lead to smaller short term profits, any faster than is necessary.

This has prompted the emergence of a new wave of smaller, electric-only lease companies, which aim to exploit what they sense is a gap in the market.

“The market is still being relatively conservative about [second-hand values],” argued Fiona Howarth, chief executive of Octopus EV, an electric car leasing arm of the Octopus Energy company that 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 in a strong way, then that would bring the monthly price down.”

As well as the lower maintenance bills, the ironclad rules of supply and demand will also strengthen residual values for used cars, predicts Howarth.

“There were 200,000 new EV cars in the UK last year, they won’t enter the second-hand market until three years’ time,” she said. By then, the number of people seeking second-hand EVs will be so high that the available cars “won’t even touch the side” of the level of demand, she added.

Last month alone, there were more than 5mn views on AutoTrader of advertisements for used electric cars, according to the online marketplace.

While electric vehicles that hold value better may be good news for new buyers who reap the benefits of lower monthly payments, it means the cars will be dearer when entering the second-hand market.

This is likely to push used buyers, who predominantly use cash or bank loans rather than depreciation-based finance deals, into leasing.

“We’re seeing significant growth in used car finance,” said Todd at VW Financial Services. He estimates roughly half the used cars sold by VW are financed, up from 35 per cent “a few years ago”.

In addition, the third-hand value of the vehicles, the factor that will determine how much second-hand buyers pay on a monthly lease, is much less certain. The data pool for cars older than six years is even shallower.

“We’re not sure how much this will be worth when five or six years old,” said Todd, “so the idea of residual value risk being covered, could be a factor as well.”

Many manufacturers, aware of this, are now offering warranty on the battery that lasts for eight years.

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

In one example, consumers in the US paid $2,000 more for an electric vehicle that contains a battery health certificate than one without, said Patrick Cresswell, managing director of Future Motion consultancy.

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

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