On Sept. 16, 2008, Master Dealer Services’ Kevin Day served as moderator for the Buy-Here, Pay-Here and Rent-to-Own Panel at the F&I and Special Finance Conference & Expo in Las Vegas. Joining him was Rob Hagen, an industry consultant and regular contributor to Special Finance; Jerry Tarbell, owner/founder of Tarbell Dealer Services Inc.; and Laura Nidelkoff, the finance director at Legacy Auto Sales in nearby Henderson, Nev. Nidelkoff and her dealership were profiled in the August 2008 issue of Special Finance.

Day: Rob, I’m going to pick on you first. The question that I think is on everyone’s minds is, what exactly is the difference between buy-here, pay-here and rent-to-own?

Hagen: Some of the differences depend on the dealership itself. Rent-to-own creates a more favorable accounting structure for dealers who don’t have deep pockets. But the biggest difference lies in who owns the car. On a rent-to-own, the car is still in the dealer’s name. In a buy-here, pay-here purchase, it’s going to be in the customer’s name. From a legal standpoint, when you start looking at having to repossess the car —

Day: With rent-to-own, the dealer retains the title?

Hagen: Yes, and one of the biggest concerns is how taxes are accounted for, from the dealer’s standpoint. That’s one of the financial factors dealers have to weigh when they’re trying to decide if they want to start doing BHPH or rent-to-own.

Day: Jerry, let’s expand on that a little bit. I’m going to throw you a trick question here: Which is better, rent-to-own or buy-here, pay-here?

Tarbell: That depends on the dealer’s standpoint. There are some definite advantages in both cases. In rent-to-own, it’s easier to repo the car. Sales tax, if you’re in a state with sales tax that applies to cars, applies to the payment as opposed to the sale price of the car. But then, if you do own the car, you have some liability. You can go get that car and resell it with the typical right-to-cure and all that. You don’t have to set up a related finance company for rent-to-own because it’s all as-earned. If you do commissionable buy-here, pay-here, then you’re going to pay taxes on the total gross profit, but if you set up a related finance company, then you can discount that contract and sell it to your finance company. Which is better? Strictly preference.

Day: And doesn’t it depend on the state that you’re in, as well? I know rent-to-own is more favorable in some states.

Tarbell: Yes, because of sales tax. That’s probably the main reason. I don’t know if there’s anyone here from Oklahoma, but in that state, I know you cannot do rent-to-own, you can only do lease-to-own. But rent-to-own is really just a month-to-month lease.

Day: So then what’s the difference between rent-to-own and lease-to-own?

Tarbell: I’ll give you an example. We set a customer up on a 36-month deal. After he makes 36 payments, he can buy the car for one more monthly payment. In a lease-to-own, you have to residualize that car from 10 to 15 to 25 percent, depending on your term. So there is one main difference: In rent-to-own, the customer can return that car at any time — it says so right in the contract.

Some dealers worry if they don’t have a customer tied up in an airtight car contract. Personally, I believe if the customer loses his job, something catastrophic happens or he just doesn’t like the car, he’s going to pitch the key and let you go get it anyway.

There is one other major difference in rent-to-own. At this point, I don’t know anybody who buys rent-to-own contracts. So if you get into RTO, don’t plan on selling your portfolio.

Day: So it’s going to take a tremendous amount of capital.

Tarbell: Yes. But in setting up these programs, we’ve had a lot of success getting funding from different lending sources, such as local banks the dealer has done business with.

Day: Laura, you work down the road here. In your store, you do strictly buy-here, pay-here; you don’t do rent-to-own at all. I’d like to know why you chose to go buy-here, pay-here instead of rent-to-own. And how much capital did you need, especially considering the lack of liquidity in the market these days? How do you sell those notes?

Nidelkoff: I can tell you that all my buy-here, pay-here is held in-house. That plus our cash deals make up almost all our sales. We very rarely use outside finance companies. The reason we chose buy-here, pay-here is because that’s where we had experience. I was lucky enough to work for a very large dealer before Legacy, and that’s how I learned buy-here, pay-here. I kind of went through the school of hard knocks; however, when I was at the big company, I was blessed with the resources to make some mistakes.

When we opened our own dealership, we probably invested only about $70,000 in our initial inventory. We do it on a small scale. We don’t sell anybody a $15,000 car on a buy-here, pay-here deal. Our cars are A to B transportation. Our deals are structured to cover the dealership from the beginning. As you grow your buy-here, pay-here program, you’re building your accounts receivable. Depending on your customer base, those are going to be a great source of monthly revenue.

Day: Speaking of revenue, let’s go back to you, Rob. What kind of return can be expected from BHPH and RTO, and are they similar?

Hagen: The return is similar, and it’s big. Most of our stores average close to $5,000 per deal. The important thing to keep in mind is that on about 30 percent of your deals, you’re not going to collect all your money. When you do the upfront accounting for it, you want to factor in about a third of your profits and put that aside in some sort of account — and don’t put those on the books immediately. Those are going to go toward future losses.

But again, on average, our dealers gross around $5,000 per deal, and that’s not even considering the finance charges. We have dealers who charge as little as 6 percent interest, which I don’t recommend, and those who charge the state maximum. Most BHPH dealers will just take that as extra money. I’m from New Orleans, where we call it lagniappe — a little something extra. That’s money that comes in down the road. But the $5,000 per unit is usually the front gross.

The typical formula we recommend is cost times two equals the minimum selling price. If you own the car for $4,000, you sell it, at a minimum, for $8,000. What you sell the car for is not going to affect how the customer pays. As Laura indicated, they’re just looking for transportation. The beautiful thing about buy-here, pay-here as opposed to using an outside lender is, nobody is going to look at the book value. The customer certainly isn’t going to bring it up. They look at the monthly or weekly payment; that’s all that matters to them.

Day: Nor does the book really matter when the dealer buys it, correct?

Hagen: Correct, absolutely. The most important thing is stocking good collateral. If it means paying $500 more at auction than you think it’s worth, well, it’s not like new-car sales, where you have to worry about the water on the lot. You’ll get what you want for that car no matter what. But if you sell them something that will break down in two weeks, they’ll bring it back just as quickly. If you put them in reliable transportation, more often than not, they’re going to make the payments.

Day: Most of the buy-here, pay-here dealers I know don’t even take the book with them when they go to the auction. Jerry, as part of your consulting work, you set up and structure new buy-here, pay-here and rent-to-own departments. If I’m running a regular retail dealership and I want to add a BHPH or RTO component, how do I get started?

Tarbell: It can be added to an existing facility very easily. Some dealers want to maybe create a separate brand and operate the new program off site. You can do it either way. But if you can do it at an existing facility, you’re not creating another overhead.

Hagen: And you have to have a solid business plan before you jump into this market. When you run out of cash, you run out of business. For example, we work with a Ford dealership that operates a separate buy-here, pay-here location. All they want to do is 20 deals a month, so when they hit that number, they virtually shut the doors on BHPH. That’s the amount of money they wanted to allocate each month, and they don’t deviate from that. But those 20 BHPH deals net almost as much as the franchise store, which has been selling new Fords since 1928. It’s phenomenal!

Day: That’s an important point. I have actually seen buy-here, pay-here dealers who were so successful, they literally sold themselves right out of business. Make sure you have a business model ahead of time, do a cash-flow analysis and stick to it. If you run out of cash, it doesn’t matter how many receivables you have; you’re done.