The continued strength of the overall art market is prompting collectors and dealers to turn to their artworks as valuable assets that can be leveraged for a wide range of uses, report private banks, insurers, dealers and auction houses. Prices across a broad spectrum of categories—modern and contemporary works in particular—have soared in recent years,
NEW YORK—The continued strength of the overall art market is prompting collectors and dealers to turn to their artworks as valuable assets that can be leveraged for a wide range of uses, report private banks, insurers, dealers and auction houses. Prices across a broad spectrum of categories—modern and contemporary works in particular—have soared in recent years, both at auction and privately. For many established collectors as well as new buyers, the appreciated value of the art hanging on their walls far exceeds the original cost of the works. Putting up such art as collateral for a loan is a way of taking advantage of the jump in value, often without having to part with the work or pay hefty taxes on a sale.
One of the strongest examples of price increases in the contemporary art world can be seen in the market for pieces by Damien Hirst. British collector Charles Saatchi bought Hirst’s 14-foot tiger shark floating in a tank of formaldehyde for £50,000 some 14 years ago. Recently Saatchi sold it for a reported £6.25 million, or about $12 million (see ANL, 1/4/05). And last May Sotheby’s notched a record for the most expensive painting ever sold at auction when Pablo Picasso’s 1905 Garçon à la pipe, took $104.2 million (see ANL, 5/25/04). The previous owners, Mr. and Mrs. John Hay Whitney, had paid about $26,000 for the work in 1950.
“For a lot of people, this is opening up something they haven’t thought about before,” suggests Suzanne Gyorgy, business manager of Citigroup Private Bank Art Advisory Service, New York. “Collectors are seeing prices going up so high—it has made many look at their collections and realize they have a lot of capital tied up in their art. In some instances, such as that of buyers who collected in the 1970s, the values have increased so dramatically that they realize it’s a great source of funds to invest or use elsewhere.
Gyorgy says the Art Advisory Service’s role in evaluating art as collateral for a loan involves intensive work with in-house researchers and art experts. To date, clients who have taken advantage of this strategy include high-end galleries and private collectors. Gyorgy describes many of the clients as “savvy business people, such as real estate developers, who use leverage frequently. We’ve also seen a lot of people in the hedge-fund or money-management business who are using their collections to buy more art or invest in their business.”
“I think it’s a very attractive, sophisticated financing mechanism,” says Katja Zigerlig, senior fine-art underwriter at the AIG Private Client Group. “The discretion and privacy component is also what makes it so appealing. It’s a way of getting funding that the whole world is not going to know about. If you have substantial assets in art and obtain a $20 million loan, it’s a private transaction between your bank and you. You don’t have to put up something more public as collateral if you’re looking to fund a new project.” Furthermore, the fact that an artwork used as collateral is insured against fire, theft and other damage “increases the comfort level for the lending institution,” says Zigerlig.
Certainly the concept of using art as collateral is not new. Citigroup has been making such loans since the 1ate 1970s. However, a number of experts say the sharp rise in the art market in recent years has fueled an increase in the use of art as an asset that can be leveraged. “We saw quite a flurry of these at the end of last year,” reports Dorit Straus, who is the worldwide fine-art
manager at the Chubb Group of Insurance Companies.
As the underwriter, the insurer wants to be certain that the client obtaining the loan is financially sound. “I must say,” Straus notes, “that I have not seen one instance where there were any financial problems surrounding the loan request. All these cases were financially sound, where people had multiple residences and assets were not an issue. It makes sense, if you bought a Roy Lichtenstein in the 1960s—why shouldn’t you use it and take a certain amount of return on your investment?”
Best of Both Worlds
The upside for collectors is that they gain increased liquidity while holding on to the works at the same time. Private banks are quick to point out, though, that such a loan is generally limited to high-net-worth clients with whom they have worked closely in an advisory role.
A big financial benefit of borrowing against an artwork, as opposed to selling it outright, is avoidance of the substantial capital gains tax, currently 28 percent, that would be triggered by selling a work for which the value has risen sharply.
For instance: A collector who initially paid $100,000 for a work and now sells it for $1 million owes $252,000 in federal capital gains tax, since the value of the work has appreciated by $900,000. (Congress lowered the rate in 1997 on almost all other assets, such as stocks, to 20 percent. In 2003 the rate was further reduced to 15 percent.)
In comparison, it is far cheaper to pay the interest rate on a loan taken against a work. Banks say that loan amounts generally approximate half a work’s appraised value; auction houses, that they tend to align with half the work’s low estimate at auction. Both say that interest rates vary according to the worth of the art and status of the borrower.
‘Plain Vanilla’ Loans
“More and more, people are thinking about art as an asset class and exploring the different types of strategies for using art as collateral and borrowing against it,” says Paul Provost, senior vice president and director of trusts, estates and appraisals at Christie’s. Loan amounts vary widely and are based on the clients’ financial profiles and the quality of the art they own. Provost reports that the most common types of “plain vanilla” loans, where clients borrow against art, are advance loans, frequently earmarked for estates needing cash to pay taxes on artworks.
Comments Mitchell Zuckerman, president of Sotheby’s Financial Services: “I used to think loan demand would increase countercyclically—in other words, in times of recession [when] you’d think more people would be looking to borrow against their artworks.” But that’s not the case now, he says, noting that loan demand often picks up around the time that major auctions are held.
Sotheby’s has several techniques for lending against artworks, Zuckerman explains, since it has the advantage of “vertical integration”—the ability to appraise, store and eventually sell the art if an auction or private sale is part of the commitment or if the borrower prefers to repay the loan by selling art rather than by writing a check.
For instance, he explains, “if you bring us a picture in June and the next auction is not until November, the auction, secured by the incoming work, can pay off a loan and preserve the upside potential in excess of the loan for the owner.” This type of transaction, known as a “bridge loan or consignor advance,” is “something we do all the time,” says Zuckerman. “You’re unlocking the equity that is stored in the art” by receiving funds well before the work is actually sold.
Simpler, Faster Loans
Among other types of deals Sotheby’s arranges are loans where the work is used as collateral but is not necessarily sold. Such loans are “a lot simpler and faster” than receiving bank loans, Zuckerman points out, since the two main requirements at Sotheby’s are establishing the auction value of a particular work or collection being put up as collateral and determining that the client has legal ownership of the work. In contrast, a bank loan calls for assessment of the client’s overall financial situation and ability to repay the loan.
The house also arranges what amounts to “trade-ins,” he says. Sometimes, before a major auction, “a collector will come to us who is interested in bidding on, say, a picture that might sell for $5 million.” He may have a picture, or several pictures, that he gives to the auction house as a contingent consignment.
“If he eventually wins the picture at auction, rather than writing us a check to buy it,” Zuckerman explains, the collector’s own painting or paintings will be used as part or all of the payment to Sotheby’s. “Basically it’s trading in your old pictures to buy a new one.”