‘Safe as houses’ and ‘you can bank on it’ are just two phrases that come to mind when most of us think about investing in some or other asset class. We have been conditioned, from the time that we were able to comprehend the concept of investments, to believe that the value of fixed property and the trustworthiness of our banks are beyond doubt. That was until the ‘toxic debt’-inspired credit crunch of 2008 - which seems to have deepened now, at the start of 2009.
With South African collectors paying millions of Rands for works by our most desirable artists, there is no doubt that our art has now become a recognised asset class. In my opinion, ‘investment art’ can be a very misleading concept as it certainly does not apply to all works of art but only to a select group. The core issue, which offers the key to understanding the characteristics and nature of this asset class, is the degree of uniqueness. Every original work of art is a unique creation, which will be interpreted by uniquely different individuals, who will all have uniquely different views about its appeal, success and value.
The investment value of any asset is ultimately determined by its desirability. How desirable a particular asset is depends on diverse factors like the emotional impact it has on the potential buyer, the intellectual stimulation it provides, its inherent quality and condition, how fashionable it is and to what degree the price matches the buyer’s perception of its current value and its potential for appreciation.
Investment characteristics
In order to make sense of these abstract concepts we need to identify and define the characteristics that determine that segment of the art market that can be regarded to be of investment quality – thereby justifying its status as an asset class:
1.Desirability
It is a sobering thought that the value of any painting is determined by its desirability only, as it has no intrinsic value such as that of a fixed property or shares in a company with a net asset value. Investments, like ‘blue chip’ shares, are rated by their historical performance and the perception of their expected future performance. These two aspects are largely responsible for the premium paid for such shares, thus reflecting their desirability. It is for this reason that most ‘investment art’ pieces are works by deceased artists who would normally fall under the ‘old masters’ category. Works by these artists have a proven track record of the change in its value over time, which offers a sound reference for predicting its future performance. With fashionable trends often evident in the art market, it obviously helps to know that a particular artist’s work has maintained its desirability over long periods of time – unlike some avant-garde contemporary works that can loose their relevance or appeal relatively quickly (Like the ‘Resistance art’ of the eighties).
2.Uniqueness
As mentioned above, we are dealing with a unique asset class. Although every work by a good artist is an original and unique creation, there needs to be consistency in terms of the technical quality, style and subject matter for the body of work to generate long term interest and thus value. Experimental works which do not lead to a stylistic development or a new series of works will never be as desirable as the works which define an artist’s oeuvre. The long term value of any artist’s body of work also requires a great enough number of works that will ensure continuous trade in it – thereby confirming and reinforcing the value over time. The value of works by artists who only produce a few hundred works in their lifetime often suffers because of the irregular trade in such works. It becomes very difficult to establish a fair current market value of a particular work when there are no records of recent sales of comparable works. Artists are often criticised for ‘repeating’ themselves when they produce works based on the same subject matter or idea – unfortunately this is exactly what is required to establish a large enough body of work to ensure its long term market value. If Hugo Naudé had only painted Namaqualand’s spring flowers once, these paintings would never have become his most sought after, and therefore valuable, works.
3.Collectability
The functionality of any work of art can generally be best described as a luxury item which provides emotional and intellectual stimulation. It is therefore obvious that, as with other luxury goods, it is only the relatively wealthy members of society who can afford it. From an investment perspective and purely as a theoretic model, it would therefore be prudent to invest in works by those artists which the biggest group of collectors are buying. This would guarantee continuity in the competition for, and trade in, these works and would result in a stable market - underpinning a steady increase in values. Internationally, artists’ careers have been made when the right museum curators and collectors started buying their work – collectors like Charles Saatchi have managed to capitalise on this characteristic of the market and made millions of Pounds because of it. The basic requirement to ensure the long term value of any body of work is therefore a large enough group of capable buyers and/or collectors. For anybody considering an investment in this alternative asset class, it would be wise to follow those in the know – the experienced collectors. Private collectors have much more at stake than any individual dealer or auctioneer, as they are spending their own money and have to consider a far greater investment risk.
4.Store of value
Given the current turmoil in financial markets globally, it is now even more important to consider the stability of the value of any asset one invests in. Historically, the values of top quality works of art have always withstood the short term volatility of the financial markets. With less cash around and with many established banks and corporations going bankrupt, all potential investors have to be extra careful about where they store their wealth. Most experts agree that the focus is now on the preservation of wealth and that the value of investments should be beyond doubt. The stability of the long term value of quality works of art can in short be ascribed to the following:
- Unlike other assets, there is passion involved and ‘the heart wills the mind’ when collecting art - it is not an unemotional, rational decision based purely on financial principles. Sentiment and the emotional involvement with a work of art usually provide endless enjoyment for the owner, bringing instant and continuous gratification that does not exist with most other financial investments.
- Art purchases are usually not financed – works are bought for cash by art lovers who can afford them. This means that it is highly unlikely that owners would come under pressure to sell as there is no debt to service and we are dealing with people who know how to generate wealth (which enabled them to purchase it in the first instance).
- The stability of the art market can also be attributed to the fact that it is a relatively small market where a handful of able buyers/collectors can ensure that it stays healthy and stable at any given time – in stark contrast to stock markets where panic selling can result in an investment’s value being eroded to a fraction of its cost in a matter of weeks.
Buying your profit
The most important difference between art and other recognised asset classes is that it does not provide any income. There is no interest, dividends or rental income and the performance of the investment is measured purely in terms of its capital appreciation. Investors will therefore have to be extra careful when deciding what a fair purchase price is as the performance of their investment will be based purely on the entry cost. Unlike other assets where investors can enjoy both income and capital appreciation, which offer greater investment security when combined, the purchase price is critical when buying a work of art. This is why an intimate knowledge and understanding of an artist’s oeuvre is so important - the desirability (read value) of a work from a particular period, of a particular subject matter or in a particular style can be multiples of that of other works by the same artist. This aspect of the art market is of course used by unscrupulous dealers to motivate inflated prices based on the record prices paid for the truly exceptional pieces. To avoid being caught in this trap, it is important to have an in depth knowledge and understanding of an artist’s oeuvre and to have reputable and trustworthy advisors.
Finding a reputable, independent art advisor is very difficult – given the subjective nature of art appreciation and the fact that most advisors/dealers/auctioneers are commission driven. The only practical alternative in the South African market is reputable galleries who are prepared to guarantee the authenticity, condition and value of the works they offer. Dealers who sell works of art as ‘investments’ should be asked to provide the same set of figures and guarantees one would typically expect from an investment advisor. Would they be prepared to guarantee the purchase price in a trade-in or buy-back situation? And, would they guarantee an annual increase in value at a particular rate?
One should not expect independent advice from agents or auctioneers who are selling works on consignment for a commission – they usually ring-fence themselves with ‘conditions of sale’ to limit their responsibility. ‘Buyer beware’ should flash in everybody’s mind when attending an auction where the auctioneer claims the right (in the small print of their ‘Conditions of Sale’) to bid ‘on behalf of the seller’ (bidding against the chandelier!), and passes the responsibility of establishing the authenticity of any work to the buyer! Most good sales people are very good at telling us what we want to hear…
When analyzing art as an asset class, another important aspect of the art market that needs to be taken into account is the transaction charges. As the purpose of most investments is to ultimately turn it into cash, the cost of liquidating an asset can have a significant influence on the final return on the capital invested. Unfortunately these charges are higher than in most other asset classes. Listed shares can be sold for a commission of as low as 1%, and an agent’s commission on fixed property usually ranges from 4 to 10% (with buyers also having to pay transfer duty of about 8 to 10%), but auctioneers and dealers in works of art operate on much higher commissions. South African auction houses charge 10 to 12% (Plus VAT) of the hammer price to both the buyer and the seller (a total of 20 to 24% plus VAT), while London auctioneers charge a buyer’s commission of 20 to 25% and a seller’s commission of about 10% on the hammer price (a total of 30 to 35%). When buying overseas, an additional import VAT at 15,4% of the invoice value (calculated on the rate of exchange when it arrives in SA) is payable to SA Customs. Most galleries charge a 20 to 30% commission to re-sell works, with the commission percentage on higher priced works usually more negotiable. It is therefore obvious, given the commission structures in the art industry, that any ‘investment’ would have to perform very well for a period of at least 5 to 7 years before the real net return would be worthwhile.
Conclusion
In my opinion, the unique characteristics of works of art that fall into the investment category warrant a strategy where it could comfortably make up 10% of any investment portfolio. The motivating factors are in short:
- Instant and continuous pleasure and enjoyment with almost no holding costs (Most serious art buyers are art lovers and not just investors).
- An excellent and stable store of value and wealth in uncertain times where other asset classes can experience severe volatility and erosion of value.
- The potential for exceptional growth in value if buying the right pieces at the right time – like now, where financial pressures will certainly force sales at prices which will offer very good value.
- No Capital Gains Tax (or any other taxes) on profits if works were bought privately as collectables and not for speculative purposes.
- An opportunity to leave a legacy that says much more about an individual than any bank balance can reflect - but with a built-in financial advantage. We have often sold inherited works where the proceeds literally changed people’s lives for the better – paying the deposit on their first home, or paying for their university education.
With South African art now an established alternative asset class, it is important to evaluate the effects of the current financial crises, and formulate a strategy to take advantage of the situation. I firmly believe that one should now look for opportunities to acquire quality works of art while the pessimists are too pre-occupied with the doom and gloom to even notice them.
Johans Borman
February 2009
© Johans Borman Fine Art