Risks Of Investing In Art

Last month I published some interesting features art has as an alternative investment alternative, but there are also some risks I want you to consider before starting to invest in this asset:

 

1. Illiquidity: Art is generally considered an illiquid asset and difficult to convert to cash. You should expect a lock-up period of at least one year for even the very popular artists. You usually need to have an appraisal and get to marketplaces such as art galleries or auction houses to find the appropriate customer, and this process can actually take a lot of time. Therefore, when investing in art you need to be prepared to have your money tied up until you can find a buyer willing to pay what you want. However, you can still get better liquidity by investing in fractional shares, which require a lower amount of capital to invest in this asset class while diversifying your portfolio. Last, remember one of the main risks is an inability to sell the item in a timely fashion.
2. Costs include handling, storage, insurance, and a certificate of authenticity, which can all come with high fees to avoid the potential risk of destruction. Art investors often plan on holding onto pieces for a long time in order to let them appreciate in value but in the meantime the investor would have to pay for maintenance and restoration. You have to physically care for the artwork and/or pay for storage because a deteriorating artwork doesn’t retain its value as well. You need to either take care of the artwork yourself or pay for storage, which can be expensive. Regarding insurance, if you have to ship it anywhere, insure it. And when it arrives, insure it again. In these cases, return on investment (ROI) comes from capital appreciation minus maintenance costs instead of just capital appreciation over time. If you display the artwork you’ll have to make decisions to ensure it maintains its original quality. Being a long-term investment means it is crucial to preserve the value of the works you invest in and avoid any hazards that might compromise the longevity and ultimately the value of a given piece. Be aware of the specific upkeep needs of the different mediums in your collection to keep them in good condition. Moreover, some pieces of art should be kept in appropriate conditions regarding humidity, sunlight, and temperature. Getting any of those three conditions wrong could easily result in damage to the piece and costly repairs that affect returns further down the line. To provide you with a quick overview, storage costs typically range from $5 per square foot to $15 per square foot and insurance annual costs are roughly equal to 1% to 2% of the artwork’s value. Regarding maintenance or conservation costs, they might range between $85 to $250 per hour. As you can see, buying a physical work of art could be pretty expensive, which is why you want to make sure your budget first aligns with the potentially high costs before committing to the artwork itself.     
3. Tax payments: you’ll be paying taxes on any gains since the IRS considers art a collectible.
4. Counterfeit risk: The collectibles market is flooded with counterfeit items, and unless an investor is well-versed in the appraisal, it would be easy to fall prey. Like making any investment, it is important to do research on what you are buying before making the investment. Investing in art could be risky because the art market is not regulated and it’s very difficult to determine the true value of artwork (in the end, it’s subjective). There are ways to help avoid getting duped including examining the certificate of authenticity (always ask for them), researching the edition number, and checking the materials. Another way to help avoid falling for a counterfeit is working with an expert or a third party such as purchasing from an auction house or working with an appraiser who can even help you to determine an artwork’s value. Always take the time to research the seller and ask any questions before making a purchase. 
5. Lack of accurate information: this is a consequence of the nature of the sales, which are often private. Moreover, many people who buy paintings don't end up selling them later on, and that fact can skew pricing samples for art. This means that there is no data if a piece of art never sells. This can affect the prices of art pieces that aren’t auctioned. In fact, besides the Artprice 100 index, the main way to know what’s being traded is from auction data. Furthermore, aside from a lack of open access to information, it can also be hard to find comparables (comps) when considering an art investment. It’s important to know what the comparative value is within the medium or era, whether you are looking at etchings, prints, photographs, paintings, etc. but, if a comparable piece of art appraised at $15,000, it doesn’t necessarily mean that one you own will appraise for the same amount. There are a lot of specific variables that go into valuing art, including the condition, whether it's an original, rarity, and so on. In fact, the value of a piece of art depends heavily on an artist’s reputation, demand for that artist’s work and type of art, the potential for appreciation over time, the economy, and other factors. For example, several factors determine the value of fine art—the size of the edition (that is, the number of prints the artist makes of one work), the significance of the work, the condition of the print, and whether it is signed and numbered by the artist. 
6. Takes a lot of knowledge to invest well: there’s a steep learning curve and you need knowledge of the art market, awareness of trends, and access to resources if you want to make profitable choices.
7. It can be difficult to know what will be popular: choosing the “right” artist or trend can be challenging. Imagine you might take an interest in an upstart artist, you like the person’s work, and it seems like people are starting to notice the talent. However, within the next year, someone might take that artist’s place. Therefore, it’s hard to predict who will stay a permanent fixture in the community and who will fade out. As a consequence, if you pay a lot for a piece of artwork and it loses value, you’ll be out of your original investment. The fact is that there’s no guarantee any artist will remain popular or create works with consistent value. It is not uncommon for an artist who is very popular today to find that the price of his/her work has dropped by half in a few years. And what´s more, even some of the most famous artists weren’t appreciated during their time. Sometimes you can mitigate that risk when you have a solid art history or appraisal foundation. It is necessary you collect up-to-date information and watch price fluctuations, as well as gather knowledge about art history and famous artists. But there are multiple markets, and a lower-priced item in one doesn’t automatically make it a steal. Depending on which market you’re investing in, you’ll see works subject to different price scaling. In any case, the value of art is quite largely based on whether the work is something that the majority of people think they have never seen before.

Remember to consider all these risks and learn about the topic before investing. It is crucial you learn about the topic before tying your cash into this investment (even if you choose to invest a very low amount in an art fund or fractional shares, diversification must always make sense).