The Harsh Math Of Fashion Rental: Fraud, Losses And Uncertainty

Last week, Christine Hunsicker, the former CEO of fashion rental company Caastle, was arrested for allegedly defrauding investors of $300 million and she posted bail of $1 million.

Caastle was previously known as a fashion high flyer, enabling fashion rental for well-known brands like Ann Taylor, Ralph Lauren, Banana Republic and others. At its peak, I was told the company was valued at over $1 billion.

Another company worth over $1 billion at its peak is the better-known fashion rental company, Rent The Runway. There’s no fraud there but today you can buy all the shares of Rent The Runway for about $20 million.

If you did that, you’d also be the owner of almost $400 million in debt and pretax losses of $73.5 million in the last reported 12 months.

Why Is Fashion Rental So Hard?

Fashion rental companies present themselves in many ways to investors. But at their heart, they are leasing companies.

In the leasing business, one word drives the profitability or loss of the business: “residuals.” It refers to what an asset is worth when the lease is over.

Why Residuals Are So Important

Residual values drive pricing and ultimately, profitability.

Let’s say you’re Hertz. You buy cars in bulk so you get them at a very good price. The price is so good that when the car is done being rented, the price you sell it for, the “residual value,” is equal to what you paid for the car.

In that circumstance, the only cost of owning the asset is the cost of your capital during the time you own it. You don’t ever have to pay for the car since you sell it for what you paid.

If rental cars were worthless when they were done being rented, the cost of renting would have to be a lot higher for Hertz to be profitable.

And that’s the problem with fashion rental. When a garment is done being rented, it has to be sold and most garments are worth only a fraction of their original retail price when they go into the resale market.

More important, predicting the value of used garments at scale is almost impossible. Each one is so unique that a $300 million revenue company like Rent The Runway is faced with an almost impossible task.

It would be safe to assume that garments are worth nothing or nearly so at the end of the rental cycle but that would mean charging customers more and attracting customers to rent garments is a tough enough business as it is.

Residuals Aren’t The Only Thing

Residuals are key but fashion rental has other challenges too.

Hertz customers pickup and dropoff the cars they rent. Fashion rental often has to be shipped and sent back and that adds cost.

And the dry cleaning. It’s hard to get scale in dry cleaning the way Hertz can run an efficient car wash at an airport location.

And the competition. Fast fashion and fashion resale/vintage with their low prices, are often an enticing alternative to fashion rental.

And the fashion change. Women now wear a lot less formal clothing in offices and the net increase in work from home reduces demand for dress-up clothing.

Rent The Runway’s stock price is the market’s assessment of the likelihood that all these challenges can be figured out and turned into an enduringly profitable business. The market doesn’t seem to be counting on it.

Can AI Help?

You would think that artificial intelligence would be just the thing to help a company predict what a garment would be worth at the end of its rental cycle.

Yasmin Topia, CEO of Sociate.ai which claims to be the fastest-learning AI in the fashion industry, says “AI will never be perfectly accurate at predicting the value of a garment six months into the future.”

Topia explains the best models use known facts—like brand, material, and season—combined with real-time signals such as social buzz, sales trends, and influencer activity.

As far as I have seen, no one has created a model for predictive valuation of inventory yet that is entirely accurate. Topia says it’s almost impossible because “a celebrity may fall from grace, a labor or other scandal can happen or a designer’s star might take off suddenly.”

Where It Goes From Here

We don’t know where AI will take this business and at the very least it’s going to take time for AI get good at predicting the value of garments and accessories in the future.

For now, the uncertainty around residual value is the key reason why fashion rental is such a tough business. So the companies that most people hear about are the ones that are allegedly fraudulent or failing.

But there’s a segment of consumers that want and will pay for fashion resale so so it’s a certainty that companies will keep trying.

Urban Outfitters, which also owns Anthropologie, Free People and other brands, has created a rental service called Nuuly. The company says it has 380,000 subscribers and that it’s profitable.

But it’s not clear how Urban Outfitters accounts for its Nuuly business. One thing it has told me is that Nuuly buys its garments from other Urban Outfitters brands at cost. It appears that Nuuly is not charged a full load including design and other overhead costs that Urban Outfitters pays.

I have not been able to get information on how Nuuly deals with residual values so it’s hard to say what the true performance of the Nuuly business is. If Nuuly is truly profitable on a standalone basis, that’s a breakthrough for the fashion rental business. Because the numbers are not broken out, there is reason for skepticism.

Eventually, someone is going to figure out the fashion rental business and how to make money at it. When that happens, it’s likely to look a lot like other rental and leasing companies.

It’s not a data and logistics business as Rent The Runway has described itself in the past, it’s a grinding business where understanding residual value is the key to success and proper pricing.

Until then, failure and fraud will get headlines but over time, residual values and other costs will get managed and priced properly and profits can be made.