Newcomers continue to stream into the burgeoning art market, and many of them are first-time buyers who, frankly, don’t know much about art.
And that, experts say, is something that should get the attention of wealth advisors.
“Those who haven’t had the background investing in that type of asset are at a huge disadvantage,” says Scott Hodes, a senior counsel at law firm Bryan Cave in Chicago.
Hodes is himself an art collector—he was lucky enough to have been tutored on the subject by his longtime client, environmental artist Christo, and his wife, artist Jeanne-Claude, who died in 2009. He also served as the attorney for the Expo Chicago art fair, which this year attacted some 40,000 visitors.
“That’s a lot of people walking through the doors, many of whom don’t know a whole lot about collecting art,” Hodes says.
The rub is that even if people are buying purely for the joy of owning fine art, studies indicate that there is usually an element of investing involved in collecting. That means people need to be careful, he says.
“The threshold question is, why are they buying?” says Hodes. “Are they buying because they like the image, or because they’re going to turn around and sell it and hopefully make a profit, or a combination of both?”
Jim Minich, a managing director with CTC | myCFO’s Capital Advisory Services, says many of his firm’s entrepreneurial and middle-market business owner clients are paying five and six figures for works of art “more for passion and because they want to have the nicer things.” They are generally not looking to art to diversify their portfolios.
A 2014 survey by Deloitte, a consultancy, found that emotional value was a key motivator for art collectors, but that the exclusive social network and status associated with buying art was increasingly drawing buyers to the art market.
At the same time, the survey showed that 76% of those buying art were doing so as collectors, but with an investment view, up from 53% in 2012. Only 3% had a pure investment view, and just 21% did so for pure passion, without an investment view.
Whatever their motivation, many newcomers to art investing and their financial advisors don’t know what they don’t know when it comes to buying art and, equally important, the many things involved once they’re ready to write a check. This opens a new path for wealth managers to enhance their service offerings.
The Art Of Collecting
“People who collect art because it’s an allocable asset today in their portfolio have to understand what they’re buying and understand the art market,” says Hodes. “The art market can be very manipulated.”
Many collectors have not done their homework, thinking they can get instant gratification by going to a dealer or art fair, he says. But the art market is the second-largest unregulated market in the world (after drugs), says Hodes. Money-laundering opportunities abound, especially with works of art bought in Asia and shipped to the U.S., where they are sold at auction or through a dealer. “In an unregulated, booming market where all kinds of financial games are being played, the innocent buyer probably is being taken advantage of.”
One option for new buyers is to hire an expert to help build a collection, says Hodes. The New York Times reported in August that the art advisor sector is swelling. Advisors usually are paid on retainer, or a rate of $150 to $300 an hour. Increasingly, they’re working on commission, typically taking 5% to 10% of the purchase price on transactions where they act as consultant.
The article said many advisors are highly knowledgeable and well connected, but cautioned that some newcomers don’t understand all the basics of the profession, such as the need to have a collector as a client. Moreover, some advisors demand two fees when they help arrange a sale: one from their client and another from the gallery selling the work, the Association of Professional Art Advisors told the newspaper.
Hodes recommends that buyers hire advisors through a written contract that sets out the terms of representation. “It ought to specify the hourly charge and, if a work is bought, what their commission is going to be or how [the advisor] is going to be compensated,” he says.
Buyers can also fall prey to frauds and forgeries. Hodes says many artists, if asked, will authenticate their work, especially if it is going to auction, to ensure what goes on the block is their work.
If the artist is no longer living, the situation is more complicated. Authentication boards exist in some cities, which have experts in certain deceased artists, but a lot of them will not authenticate, fearing they could be held liable if the piece turns out to be a fake, according to Hodes. In New York, proposed legislation would give immunity from litigation to authenticators in certain situations, he says.
For those who buy art at auction, Hodes has a cardinal rule: “I would advise any buyer to read carefully the rules of auction and determine exactly what prechecks have been made by the auction house.” The big houses will probably offer protection if the work turns out not to be good, he says, but smaller local auction houses across the U.S. are not staffed to do the work the major ones do. “So in their rules of auction, they will put in that the buyer buys ‘as is, where is.’”
In other words, the buyer can’t invoke buyer’s remorse if, for example, the work turns out not to be authentic or was stolen. In the U.S., one cannot make title to a stolen work of art.
Devil In The Details
First-time art buyers are often stunned by the details they must attend to when considering a fine art purchase, says Kimeral Anthony, an account executive at ABD Insurance & Financial Services.
Anthony advises her clients, “Look before you leap. Before you even think about finalizing a wire transfer, check with your insurance advisor to make certain either your current insurer will actually extend terms and provide coverage in transit [of the art purchase] or that your advisor can help guide you to an insurer who will.”
Art buyers may find that middle-market insurers, such as State Farm, Allstate and Farmers, will not insure something worth $5 million. For that, the buyer needs a high-end carrier—Chubb, AIG, Ace or PURE. “But the caveat is that just because you’re with a high-net-worth insurer, it doesn’t mean they will extend coverage on what you’re buying,” says Anthony.
They very well may not or may do so only if the client already has fine arts coverage for a significant amount with the carrier. “Give yourself plenty of lead time before finalizing your purchase, a minimum of 60 days, and depending on the significance of the art and the value, that time period could be extended to six months or a year,” she says.
Besides insurance, buying a work of art involves several other “moving parts” that people never think about, according to Anthony. Take logistics. A valuable piece can’t simply be shipped to its final destination—or be packed by the buyer and put into the backseat of a car. A team of experienced fine art handlers will have to measure the piece to determine whether it requires custom-made, museum-quality crating. The people who are packaging and transporting the art must be professionally trained to do so.
And during this entire process, security must be on site, paid for by the buyer. “Essentially, no one is alone with this piece,” says Anthony. Security has to accompany the artwork in transit to its final destination, perhaps the buyer’s home, and measures to safeguard the piece must be in place there to make the insurance company comfortable with the risk.
In addition, personnel must be available for the installation, a process in itself. First, the piece has to just sit in its new environment, probably for 48 hours, to become acclimatized to the temperature in its new environment. Then, the team comes back and completes the installation.
“Sometimes clients try to cut corners,” says Anthony. “They’re not acclimated to what they’re getting into because they’ve never done it before so it sounds foreign to them.”
Wealth Management Services
In the Deloitte survey, 62% of collectors said they would like their wealth managers to include art and collectibles in their service offerings. The industry is getting the message. Eighty-eight percent of family offices and 64% of private banks surveyed said estate planning around art and collectibles was a strategic focus in the coming year.
Hodes says art financing has become a big game for some major banks in their trusts and estates divisions, though they don’t know the ins and outs of making loans on art. “Banks have loaned against art in New York for many years, but now they realize that art is an allocable asset, and when they’re dealing with art, they have to do so differently from other assets,” he says.
According to Minich, CTC | myCFO’s parent, the Bank of Montreal, is building a presence in the art financing space. As a commercial lender, he says, it is never looking to the art as its primary source of repayment. The bank has to get comfortable with art as the collateral piece, but it doesn’t expect to have to seize the art. “You’re making a loan to a rich person with multiple repayment sources to buy a piece of art; you’re not making an art loan,” he says.
Lending institutions find it critical to understand the volatility in the pricing in the market. “With Picassos, there’s a limit to how far it could fall,” says Minich. “You could feel comfortable if you had a collection of those as your collateral; you could offer a good advance rate.”
