Do you know where most used cars come from? 

Millions are sold at dealer-only car auctions every year.  Such car auctions are restricted to licensed dealers, and the general public cannot participate.  These exchanges establish the wholesale prices of used vehicles:  the prices at which dealers sell to other dealers.  Wholesale prices are considerably lower than retail prices advertised on any dealer’s lot.  Why would dealers forgo potentially higher sticker prices to take their inventory to a dealer car auction to be auctioned off for thousands less than retail?  Is something wrong with the cars that end up at the car auctions?  Why don't dealers go after a bigger margin by selling those same cars at their own lot?

There are a number of vehicles that dealers have tried selling on their lots for some time without movement, so they clear out stale inventory by remarketing them at car auctions, sometimes at a loss from what they originally paid or gave in trade.  Maintenance of aging inventory costs dealers money, lot space and reputation.  However, old or otherwise unattractive inventory accounts for only a miniscule portion of vehicles sold at car auctions. The vast majority of vehicles sold at dealer auctions come from recent off-lease returns, replaced rental fleets, company cars, repossessed vehicles and trade-ins.

Let’s look at these sources individually and examine the advantages or risks associated with each of them:

Off-lease: vehicles returned to the lending financial institution at the end of a lease term. Closed auctions are usually the only venue for such financial institutions to dispose of a large volume of end-of-lease returns.
Advantages: the terms of a lease normally put a restriction on the number of miles driven, require regular maintenance and provide penalties for above average/excessive wear.  Usually, off-lease vehicles are returned within 2-3 years, often before their original factory warranty expires.
Risks: off-lease vehicles are older - two or three years are standard terms of lease.

Off-rental: rental companies normally replace their fleets once a year, releasing a flood of late-model cars to the secondary market. Like the big financial institutions that underwrite car leases, rental companies also rely on car auctions to sell off their used inventory.
Advantages: these vehicles are well maintained and driven for only one year.
Risks: mileage tends to accumulate quickly on a rental car. Optional features usually are skimpy - you can rely on their having air conditioning and automatic transmission, but most are likely to be lower-option models. Wear-and-tear usage of rental cars is hard:  a wide range of drivers unfamiliar with the vehicle put stresses on the vehicle far beyond those of a normal one-driver car.

Company/fleet cars: companies of varying sizes own or lease cars, trucks or vans that they typically keep for two or more years, although it is not uncommon to see current year models sold at the car auctions.
Advantages: regular maintenance and large volumes of similar vehicles.
Risks: except for luxury executive models, these vehicles usually do not have many options/extras, and many get driven hard on a daily basis (like delivery trucks that regularly mount curbs and get used heavily in city traffic).

Repossessed: vehicles can be voluntarily or involuntarily repossessed by financial institutions for delinquency or another reason for recall. Car auctions are again the bank’s only option for deliverance.
Advantages: repossessed vehicles can sometimes be purchased for less because the financial institution disposing of them may be seeking only to offset its losses (due to restrictions of a federal regulation).
Risks: the condition of such cars may be compromised by neglect. There is also the potential for sabotage from ill-meaning previous users who may take out their anger/frustration on the vehicle (think extensive keying or tearing of the interior).

Trade-in: dealer inventory that is aging or does not meet their profile (e.g., your old Honda Escord that you traded in for a shiny new Mini Cooper S at a BMW franchised dealership).
Advantages: traded-in cars may have desirable extras and sometimes even after-market modifications (for those who consider this an advantage).
Risks: the overall condition of such vehicles varies greatly. Some may be considerably older and out of warranty.

Among these types of vehicles one can find a good number of quality cars ready to re-market. Late models with remaining factory warranty are not uncommon. The law requires listing dealers to disclose known mechanical problems, which may void the manufacturer’s warranty and classify the vehicle as junk, salvage, lemon/consumer buy-back, etc. There are special car auctions (for the adventurous and the mechanically inclined) which sell salvage, rebuilt or junk vehicles, whose source is mostly insurance companies. Other types of car auctions specialize in the sale of police or government cars (and some of these permit public access).

Pricing. Regardless of their source, vehicles are sent to auction with the main purpose to be sold quickly and hassle-free, and this usually happens at prices that dealers can easily recoup with a small profit from a resale. You have probably heard stories that cars can be bought at the dealer car auctions for unreasonably low prices. This may happen if there are not enough interested bidders or if the vehicle is exceptionally unattractive, but it is rarely the case and should not be taken for granted. In fact, many sellers put reserve prices on their stock specifically to prevent this from happening. The reserve price is not disclosed publicly and a “winning” auction bid is only considered a sale if the reserve price is met. Sellers have the option to re-list vehicles that did not sell at a particular car auction.

Condition. As with any used vehicle, one should not expect to find a car in pristine condition at the auctions. Used cars are for people who do not value the “new car smell” so highly as to spend a few thousand dollars extra at the franchise dealer’s showroom to get it.  Aspects of vehicle appearance may show everyday wear-and-tear, and one can expect such things as: stained or worn upholstery, scratched bumpers, dings/chips/dents on the doors, hood, and quarter panels. Most of these can be fixed with touch-up paint and/or a dent removal kit.  Scraped wheels and worn tires may need to repaired/replaced.

Inspection. Pre-sale inspection or test-driving is not allowed at the auctions. The most a buying dealer can hope is to visually inspect the car and turn the engine on, without actually driving it. Mechanics and guests are not allowed to see the cars until after the sale is completed. Some auction locations inspect and prepare the cars for sale if the listing dealer so chooses (at a premium). More extensive reconditioning is also available.

Dealer auctions are an indispensable clearinghouse of used vehicles, offering both a wider exposure to selling dealers as well as an unmatched variety to buyers. Understanding how these car dealer auctions work and what to expect to find there helps alleviate some of the anxiety related to taking part in them.