Used car market showing no signs of slowdown

The anatomy of a car auction
The anatomy of a car auction

Tariq Khan says he can feel it in his gut.

When he sees a used car or truck he knows he can sell for a healthy profit, the auto dealer from Villa Park, Illinois, jumps on it.

"I walk around it, check the record, but it's ultimately a gut feeling," Khan said. "You have to buy the right car at the right price."

For Khan, the right price for a 2004 Lexus LS 430 was $7,500.

"I'll probably sell it for nine or 10 grand," he said.

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Khan is one of several hundred auto dealers who spent a rainy day at the Manheim auto auction in Matteson, Illinois, where thousands of used cars are bought and sold.

"Very few people realize used car sales are probably three times bigger than the new car industry sales. The used car industry really fuels what happens with auto sales," said Sandy Schwartz, president of Cox Automotive, which, like Manheim, is a subsidiary of Cox Enterprises.

Dealers don't need to be told. They're riding a bull market that has steadily driven the number of used cars sold to an expected total of 41.5 million this year, an increase of 1.5 percent from 2013, according to IBISWorld.

New wave pushing supply

One reason used car prices and profit margins have been strong over the last five years is the tight supply of pre-owned vehicles. Because automakers built far fewer vehicles in 2010 due to the recession and record-low demand for new vehicles, it's harder to find late-model used vehicles.

Some call it the three-year pinch in the used car market. But that's finally starting to change as models sold or leased in late 2011 and 2012 are being traded in or are coming off lease.

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"We are going to have so many cars coming to the marketplace and I think people will find better deals," Schwartz said. "That will fuel [a] strong pre-owned car market, I believe, for the next four or five years."

Used cars are displayed outside of a CarMax dealership in Burbank, California, on June 17, 2014.
Patrick T. Fallon | Bloomberg | Getty Images

A greater supply will not only give people more choices when they're looking for a used car or truck, it will also help bring down prices. Now, the average wholesale price dealers pay for used vehicles at auction is just over $12,000—up roughly 30 percent since 2009, when used vehicle sales bottomed out during the recession.

For now, profit margins have not been squeezed, but with more used cars for sale that possibility is one dealers are watching closely.

"Pricing should come down considerably as more vehicles come off lease," Morningstar analyst Dave Whiston said.

Certified pre-owned in demand

While sales of used vehicles have long outpaced new vehicle sales, demand is increasingly being driven by people who want certified pre-owned models. These vehicles have been inspected by dealers, often have fewer miles and usually come with a warranty that extends for several years.

"The hottest thing we see today is certified pre-owned cars," Schwartz said. "Remember years ago a car that was 3 years old was old. Today, a 3-year-old car with 36,000 miles in many ways is like a new car, especially if it has been certified."

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The growth in certified models has helped dealers drive used vehicle profit margins to $2,361 in 2013, almost double what they were for new vehicles sold last year.

Whether certified pre-owned or an older model with a few issues, Manheim estimates more than 41 million used vehicles are expected to be sold this year. That could include the Mazda CX9 Khan bought at the Manheim auction for $10,360.

"I'll probably wind up selling it for $12,000 or $12,500," Khan said.

—By CNBC's Phil LeBeau

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