What is depreciation?

Most vehicle owners are familiar with the old saying that a car loses value as soon as the buyer drives it out of the showroom.

And in general, it’s true that cars do lose value as soon as they land in the hands of an owner, at which point they become ‘used’ rather than ‘new’.

Figures vary, but depreciation is often estimated to be between 10 and 15 per cent of the car’s purchase price within the first year of ownership.

That reflects the possibility that you might decide you hate your new car five minutes into the first drive, then turn around and return it to the dealership.

That’s an extreme case, but it’s not unknown for owners to sell their cars back to the dealer well within 12 months if their business suddenly collapses, for example, or perhaps the ATO takes unseemly interest in their business accounts, or their employer offers them a company car and their present vehicle becomes superfluous to their needs.

Even five minutes after leaving the dealership such a car is no longer technically new – and it can’t be advertised and sold as a new car any more than a demonstrator can.

If the dealer takes the car back off your hands the second buyer has to cover the overheads – paying more than the new price. Those overheads include the labour costs for preparation again and transferring the registration, plus any interest the dealer may be paying on floor plan – the cost of financing the inventory.

Naturally, if the dealer smells your fear, they will not only take the car off your hands, they’ll take your hands as well. It has to be a profitable exercise for them anyway; it might as well be very profitable.

So that is depreciation: the amount of money you lose on the value of a car over a period of time, from the moment you purchase it to the moment you sell. And that period of ownership could be five years… or five minutes.

Of course, some new cars can appreciate from the minute they leave the showroom if demand significantly exceeds supply, which is currently the case with many new models due to COVID-related production issues like the semi-conductor shortage (see below).

Traditionally, that’s also the case with exotic limited-edition luxury or performance cars and hotly anticipated models, perhaps including the new Toyota LandCruiser.

The concept of depreciation is quite simple; it’s just maths. Money lost between the purchase of a car (usually from new) and its sale to its next owner is the depreciation. Take the depreciation away from the purchase price and you’re left with the selling price or resale value (also known as ‘retained value’).

Deduct the retained value (‘RV’) away from the original purchase price and you’re left with the depreciation. Expressed mathematically, that’s ‘New’ – ‘RV’ = ‘depreciation’.

The depreciation can be expressed in dollars – as in: “I lost 5000 bucks on the car when I came to sell it…” – but depreciation is usually calculated by market researchers like RedBook in percentages over the course of years.

If you’ve owned a car for say five years, the depreciation of an averaged annual percentage may be an arithmetic trend – a straight line of 10 per cent per annum.

But depreciation is actually a geometric trend in practice. It follows a curve, usually starting off steep and gradually flattening out as the car ages.

The depreciation after the first year may be 10 per cent, 15 per cent, or even higher. With each successive year, however, the percentage should decline – to below 10 per cent, and well below after a number of years.

Graphed on a chart, the depreciation trend is a straight line, but the real depreciation usually follows that curve, which plateaus (flattens out) over time.

Unless you’ve bought a new car since the onset of the COVID-19 pandemic (see below) or your car is some gold-standard collectible that never loses value, you can expect your car to be worth less after a year or two than it cost you to buy in the first place.

The reason for the large decline in value during the first year has already been explained, but the question then remains: Why do cars continue to depreciate?

To a large extent it’s about our ingrained thinking. We have the first-year precedent to thank for that, courtesy of the motor car traders, so we presume then that the older a car is, the less we expect to pay for it – until around year 30, when the vehicle may gain value for its rarity.

The car is rare after 30 years because most similar models have been written off or have been sold to the wreckers for scrap by then.

Used car traders feed into this thinking. Their business model is to buy a car cheaply and sell it with a detailing and a warranty for a price not as cheap – but still less than the price of a newer car.

All else being equal (condition, kilometres, standard and optional features fitted) we expect to pay less for a five-year-old car than a three-year-old car.

Another difference between cars of a varying age is that one may be a new generation of that model. It may be more sophisticated, in terms of engineering and packaging, for example. And that could be another reason why the newer car is worth more than the older one.

An example of the way depreciation plays out in a conventional market is the Volkswagen Golf GTI, although in the current market, even the sporty VW’s RVs are not consistent with history.

Taking the Golf GTI 7.5 to illustrate:
2020 model sold new for $47,190, RV is $41,300 (depreciation: 12.5%)
2019 model sold new for $46,190, RV is $38,000 (depreciation: 17.7% over the two years)
2018 model sold new for $44,490, RV is $34,300 (depreciation over three years: 22.9%)
2017 model sold new for $43,990, RV is $30,600 (depreciation over four years: 30.4%)
Average depreciation over the four years, according to RedBook, is around 21 per cent.

A popular, volume-selling car, such as the Toyota Yaris ZR five-door hatch sold here between 2014 and 2020, is an example of how freaky the current market is (for buyers in particular).

A car like this would be expected to lose a certain amount of value every successive year, starting with that huge initial hit during the first 12 months of ownership.

But something remarkable has happened in the market over the past couple of years.

In its final year the Yaris ZR sold new for $22,670. Amazingly, and echoing the higher starting price of its successor, the 2020 model of Yaris ZR auto is valued by RedBook at $25,400 in ‘good retail’ condition.

That means it’s notionally worth more than the price when new after 12 months on the road. And depreciation (or appreciation, in fact) doesn’t stop after the first year of Yaris ownership either.

Currently, the Yaris ZR’s depreciation looks like this:
2020 model sold new for $22,670, RV is $25,400 (depreciation: -12.0 per cent)
2019 model sold new for $22,670, RV is $25,200 (depreciation over two years: -11.2 per cent)
2018 model sold new for $22,570, RV is $23,400 (depreciation over three years: -3.7 per cent)
2017 model sold new for $22,470, RV is $21,900 (depreciation over four years: 2.5 per cent)
2016 model sold new for $21,290, RV is $19,500 (depreciation over five years: 8.4 per cent)

So after five years of ownership, the estimated market value of the Yaris ZR has barely moved. You’ve paid the on-road costs up front (registration, stamp duty and compulsory third-party insurance) and operating expenses, but little else.

Normally, though, circumstances just don’t pan out that way.

Since the advent of the coronavirus pandemic, supply of new vehicles to the market here in Australia has been squeezed tight.

It’s hard to lay hands on new cars because vehicle assembly line workers have been in isolation overseas, and their plants closed, or there has been a global shortage of semi-conductors – which recently reduced automotive production by up to 40 per cent for a giant like Toyota.

Shipping capacity can’t keep up with demand either, and there was that vessel that blocked the Suez Canal that time.

So supply constraints are pushing up demand for new cars, and prices are helped along by car companies raising the prices as they drive their product lines upmarket.

Yet people are still buying new cars and can’t get enough. If they can’t get into a new car, they’ll hold their used car longer, which makes that – and other hoarded used cars in the market – increasingly valuable to someone in the market for a three/five/seven-year-old car because they can’t afford to buy new.

So new-car supply constraint has a trickle-down effect on the prices of used cars too. As the demand for used cars starts to rise insatiably, so do the prices – and that means that depreciation may not be the problem you expected when you bought that new car five years ago.

How to boost your car’s resale value:

There are various reasons why a car might depreciate rapidly, even in a market like this one. It’s sad to say, but the otherwise reputable Holden Astra is now an orphan since General Motors canned Holden in February 2020.

As a guide, the Astra RS-V auto was listed at $32,990 new at the start of 2020. Its good retail value in the used market is $27,500, which is actually the sort of depreciation usually expected in a normal market. It works out to about 16.6 per cent depreciation after a year and a half.

The Astra in this specification continues to depreciate too, as follows:
2020 model sold new for $32,990, RV is $27,500 (depreciation: 16.6 per cent)
2019 model sold new for $31,740, RV is $25,800 (depreciation over two years: 18.7 per cent)
2018 model sold new for $31,740, RV is $23,800 (depreciation over three years: 25.0 per cent)
2017 model sold new for $31,740, RV is $22,500 (depreciation over four years: 29.1 per cent)
2016 model sold new for $31,740, RV is $19,900 (depreciation over five years: 37.3 per cent)

The average depreciation for the Astra works out at 25.4 per cent over the five years. In a normal market the Astra could be expected to have lost value faster still, being an orphan.

As is shown in the cases of all three cars – the Golf GTI, the Yaris and the Astra – the depreciation curve is currently behaving in different ways, all of them seemingly divergent from the norm.

It’s either curving up and then gradually making a transition to a gentle decline (Yaris), initially losing a lot of ground, then flattening out briefly and finally plummeting like a rock (Astra), or it’s depreciating faster as time goes by (Golf).