Forbes

Considerations For Art As An Investment
by Sir Daniel Winn

Forbes Councils Member
[as originally published on forbes.com]

Increasingly, wealth managers are recommending fine art as a regular part of their clients’ investment portfolios. The Art & Finance Report 2019, published by Deloitte Luxembourg in cooperation with ArtTactic, indicates that 72% of wealth managers, including both private banks and family offices, actually offer art-related services. An additional 14%, who don’t currently offer such services, believe there is a convincing argument to do so.

On the demand side, the report found that 81% of art collectors seek art-related services from their wealth managers. This is a significant increase from the 2017 survey, which reported the number at 66%. The most sought-after services include art & estate planning (76% of collectors), art as loan collateral (69% of collectors), and art philanthropy services (65% of collectors).

In the gallery business, we often say that art collectors are motivated by three factors: fame, fortune and fulfillment. Deloitte’s report finds that collectors are moving away from fame (i.e., social status) motivations in favor of fortune motivations: Only 49% of collectors surveyed responded that “social value” was the most important motivating factor, down from 63% in 2017.

Additionally, 52% of collectors identified “portfolio diversification” as a strong to very strong motivator, up from 36% in 2017. Interestingly, there is evidence of a shift from art as a short-term investment vehicle toward art as an instrument of financial stability with a 7% increase in “inflation hedge” and a 4% increase in “safe haven” motivations.

The financial motivations appear to be sound. The top 100 artists realized a compound annual growth rate of 8% between 2000 and 2018. The compound annual growth rate across other art categories varied from 2% to 9%, with the biggest gains seen in Post-War and Contemporary art. Compare this to a compound annual growth rate of 3% for the S&P 500 over the same period.

Investing in art, however, presents particular challenges that generally aren’t prevalent in other investment instruments. The most significant issues center around authenticity, auction fees and liquidity.

Issues of authenticity are more significant for art and other collectibles than for stocks and bonds, though with common sense and a little education they can be avoided. You wouldn’t buy shares of IBM without proper documentation or from a shady character selling out of a back alley, so you shouldn’t buy your Picasso paintings that way either.

Buy from a reputable dealer or auction house and carefully examine the provenance documents (certificates of authenticity, previous sale invoices, etc.). If those documents don’t exist or appear inadequate, don’t buy without consulting an independent expert on the artist’s work. And, as with real estate, if the price is too good to be true, you’re probably not getting what you think you’re getting.

Collectors often purchase through auction houses as a safeguard against authenticity issues. While this is generally valid — no reputable auction house would knowingly offer a forgery — it isn’t a sure thing because auction houses typically don’t guarantee authenticity. It also comes with a steep price as the houses collect additional amounts from both the buyer and the seller in the form of “premiums” and “commissions.”

The percentages vary between auction houses and decrease somewhat as the hammer price increases, but in my experience, the major auction houses generally charge a 10% seller’s commission and a 25% buyer’s premium on sales of $300,000 or below. That means that if the final bid is $100,000, the seller receives $90,000 (excluding miscellaneous fee deductions or “performance commission” upcharges), while the buyer pays $125,000 (excluding applicable taxes). On such a sale, the auction house gets at least $35,000 for its efforts.

Finally, a potential investor needs to understand that art is a highly illiquid asset. Unlike publicly-traded stocks, there are no centralized exchanges for art, and it can take months or even years to find a buyer. Auction houses increase liquidity somewhat for auction-quality work. The report found that 80% to 88% of works acquired at auction and held over ten years can be resold at auction for more than their original purchase price, though not necessarily at a profit given the auction house commissions, premiums and fees.

There are, however, two strategies that can be employed to mitigate liquidity issues: art-secured lending and tax-deductible donation.

An estimated $21 to $24 billion in loans were secured by art in 2019, with 90% to 92% made to private individuals. Private banks made approximately 84% of those loans, boutique lenders made about 7% and auction houses made the remaining loans.

There are also financial gains to be realized through tax-deductible donations of fine art to qualified charities. This liquidity alternative tends to be most successful with well-managed emerging and mid-career artists whose work can be bought well and realize rapid and significant valuation increases.

There are compelling reasons for high-net-worth individuals to include fine art in their investment strategies. The data shows that more and more are doing so, with their wealth managers playing an increasing role. As with all investments, they need to understand the risks and issues unique to art investing and rely upon qualified and reputable experts in the field.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.