Galleries Are Shuttering But the Digital Art Market Is Hot

In 1964, Robert and Beatrice Mayer spotted an eye-catching painting titled Buffalo II by then up-and-coming artist Robert Rauschenberg. The $16,900 price tag might have seemed steep. But when the gavel struck at Christie’s auction house in New York in 2015, the painting fetched $88.8 million. That works out to an 18.3% annual return, nearly double that of the S&P 500 with dividends reinvested in the same period. The stunning price for the Rauschenberg came seven years after the artist had died. As art collectors often say, “death sells.”

Today, global interest in art is rising, thanks to the pandemic (as people spend less on things like travel) and a desire to diversify away from the stocks-and-bonds axis. Yet art’s illiquid nature suggests that only those with sufficient means and patience should invest in this wealth-preserving alternative asset.  

Larry Fink, CEO of BlackRock Investments, told attendees at a 2015 conference in Singapore that along with high-end apartments, contemporary art  is “among the two greatest stores of wealth internationally today ... and I don’t mean that as a joke, I mean that as a serious asset class.”

Many more are coming around to that view. A survey last month of high-net-worth investors by UBS and Art Basel found that “59% felt the Covid-19 pandemic had increased their interest in (art) collecting, including 31% saying that it had significantly done so.” Periods of economic stress often boost the appeal of alternative assets, like gold, real estate, and art.

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Contemporary artists, in particular, are attracting interest. Their works now account for 15% of the global art resale market, according to Artprice. That’s up from 3% in 2000, lagging only modern art (43%) and postwar art (24%).

For some, outright ownership of art remains the best way to invest. For others, fractional ownership provides the benefits of diversification while gaining access to top artists.

But no matter the price tag or share of ownership, financial advisors should play a central role in helping their clients find, purchase, and eventually sell art.

That Rauschenberg painting was an outlier. Studies of annualized returns for art investors vary greatly. Artprice indexes 100 “blue-chip” artists to help financiers and investors “quantify the art market’s value accretion by focusing on its most stable elements.” From 2000 through 2018 (the most recent data available), they found that sales prices rose at an 8.9% yearly pace, more than doubling the return of the S&P 500. The Artprice100 index “essentially identifies the 100 top-performing artists at auction over the previous five years who satisfy a key liquidity criterion.”

Of course, time periods matter. In the most recent decade (covering much of the second half of the time period of that study), stocks went on a tear, while the art market grew just 9%, according to Deloitte.

And a 2014 academic study found that from 1900 through 2012, stocks delivered a 5.2% average annual real return (i.e. after inflation) compared to a basket of collectibles that included art, stamps, and violins, which rose between 2.4% and 2.8% per year in real terms.

The lesson is that investments in art are best done to diversify portfolios and preserve wealth, not for their growth.

Since the mid-1700s, Christie’s and Sotheby’s have been matching art buyers and sellers, typically catering to high-net-worth investors. They, along with Phillips, still account for roughly two-thirds of the global art auction market today, according to Artprice. Yet in recent years, newer and more accessible art investment platforms have sprung up.

New York-based Masterworks, for example, aims to do for the art world what NetJets did for the globe-setting set — provide access to a rarified good (or service) via fractional ownership.

After founding various tech companies and building his own art collection, Scott Lynn launched Masterworks in 2017 to combine his interests in art and investing. “In the past, it’s been hard to use art as part of an asset allocation process,” he says.

Lynn’s business started slowly. “It took us 15 months to get our investment vehicle qualified by the SEC,” he notes. As a result, Masterworks bought just five pieces before 2020. Yet the business model has caught fire this year. More than 10,000 new users are registering each month with Masterworks, according to Lynn. “We now have 90,000 investors on our platform and we’re able to do a fresh offering of a new piece each week.”  Masterworks is on pace to invest more than $100 million in new art works this year.

The art world has gone digital in a hurry, thanks to the pandemic. Christie’s, Sotheby’s, and Phillips held roughly 125 online auctions in the first half of 2020, which is more than twice as many as in the year ago period. And the aforementioned UBS and Art Basel report indicates that in the first half of this year, online sales accounted for 37% of total sales, compared to 10% in 2019. At the same time, gallery sales, on average, plunged 36% year over year as 93% of galleries closed this year.

Moreover, art acquired through auction houses can result in stiff transaction costs as buyers and sellers are charged a fee that can approach six figures for especially high-end works. And once you own a work of art, the costs continue to pile on. Insurance, storage, and appraisal costs are some of the expenses to consider.

Those costs explain why many investors prefer to invest in Fine Arts funds. Firms such as Swiss-based investment boutique Anthea and London-based the Fine Art Group are among a select few that cater to wealthy investors. The funds tend to pool millions in assets and own a broad collection of paintings and sculptures. Historically, such funds have tended to generate 6% to 8% annualized returns before fees.

Masterworks’ business model stands in clear contrast to those art investment funds, providing an opportunity to own shares in one specific artwork just as investors can own shares in a company. When a work of art goes up for sale, a specified number of fractional shares are determined and registered with the Securities & Exchange Commission (SEC). Once those shares have been bought and registered, they can be re-sold at any time on Masterwork’s secondary sales market. The firm doesn’t charge any markups to facilitate those transactions. Each investment generates a K-1 tax form, which can complicate tax planning.

According to Masterworks’ website, “the team selects paintings based on a review of sales data for similar works with historical appreciation rates between 9-15%.” Lynn says that his firm’s size and buying power enables it to “negotiate away most of the commission on the majority of lots from auction houses.” The focus here is on top-selling artists such as Van Gogh, Kahlo, and Basquiat.

Lastly, owning fractional art has a series of direct and indirect costs. Masterworks, for example, charges a 1.5% annual management fee and also takes 20% of the profit from any eventual sale. High net-worth investors are used to this kind of fee structure with their hedge fund investments, but many other investors may balk at the notion of surrendering that kind of profit.

Marc Schindler, a co-founder of Houston-based Pivot Point Advisors, has been collecting art for more than 30 years, and is able to provide key insights to clients as they look to start building their own collections. Schindler has come to know all the key players in his region, from key galleries to up-and-coming local artists who are seeing their work rise in price. “Having a lot of local market knowledge can be a really big help when it comes to art investing,” he says.

Advisors like Schindler can also help clients identify local or regional art appraisers, storage facilities, and best practices when it comes to insuring art. Lesser-priced works of art tend to be covered by homeowner’s insurance policies, though art worth more than $10,000 often needs to be insured by a specialist insurer such as Chubb, Cigna, and New York-based Art Insurance Now.

Investing in art, however, has one major drawback when compared to stocks and bonds: The long-term capital gains tax rate on the sale of collectibles is 28%, above the 20% capital gains rate levied on financial investments for most clients. (Netting out capital gains and losses for art investments is also a bit trickier.) The tax picture explains why many collectors hold on to art throughout their lifetimes as a storehouse of value. Their heirs will receive a full step-up in basis to the current appraised value.

Still, gifting the art while alive and taking advantage of the $11.8 million (for couples) lifetime gift tax exclusion can help reduce the size of an estate for estate tax planning purposes. The downside to this approach is that the recipient of the gift does not receive a step up in basis when they eventually sell the art.  

David Sterman, CFP, is President of New Paltz, NY-based Huguenot Financial Planning

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