Sunday, July 28, 2019

Art Shares?

When people start investing in dubious and wacky things, if it's a sure sign a crash is coming.

A recent article in the New York Times talks about a new concept for investing in art and other collectibles.   For the most part, it sounds like a good way for the people running these schemes to make a lot of money.  What they do is buy a piece of art, such as a Warhol, and then mark up the price substantially and sell off shares of it to different people, much as you would sell shares of stock.

The idea is, this allows the "little guy" to invest in big-league art without having to buy an entire painting. Rather, he buys merely a share in the painting and thus he can see his share increase in value as the painting goes up in value.  That's the theory, anyway.

There are a number of problems with this model. To begin with, the person selling the shares has generally marked up the value of the painting so that the value of the share that you buy is more than its equivalent market price.  Right off the bat, you're starting off at a disadvantage in that you have paid more for your share of the painting than that fraction of the painting is worth at current market values.  You have to hope the painting goes up in value considerably just to make your money back.

And then there is the issue of getting your money back. You have to hope that there is a market for your shares, and the market for these shares is determined by the laws of supply and demand, which may not necessarily follow art market values of the underlying painting.

If you own an Andy Warhol painting and you see it go up in value, you have the choice of deciding to hang on to it or sell it. You could then sell it and cash out and make a lot of money.  But as a shareholder in a painting, you cannot force the sale of it and your only recourse is to hope somebody else is interested in buying a share of the painting.

The problem is, the laws of supply and demand for paintings as a whole, versus shares of paintings do not correlate to one another.   The former is at least a known historical quantity, the latter is so novel as to be unknown.  People buy an Andy Warhol painting and hang it on their wall so they can show it off to their friends as how wealthy they are and what great taste they have in art.   A person buying a share in a Warhol painting is merely investing in a commodity that they hope will go up in value.  There is far less value in a share than in the corresponding fraction of the painting itself.  If you owned 50% of the shares, it is worth less than 50% of the painting value because you don't have the painting or even half of it, to enjoy.

Even if the painting goes up in value, the demand for shares in the painting by not go up as well. Since these are shares marketed toward the small investor, if economic conditions change, small investors may shy away from such investments and thus it may be difficult to sell your share.

This type of investment scenario also raises the possibility that these paintings end up perpetually in limbo.  In order for the painting to eventually be sold to another buyer, someone would have to buy a majority of shares in the painting in order to force a sale of the painting.  However, by the very nature of purchasing the shares, the buyer would drive up the price of the shares, making it all but impossible to purchase a majority stake in the painting to force a sale.  Well of course, it could be possible to buy all the shares necessary to force the sale, but since the share prices would escalate, the more you purchase them, the ultimate purchase price for a majority stake would be more than would be yielded by the sale of the painting.

Meanwhile, you have to ask yourself where the painting is going to reside.  Will it sit in some dark vault, never to be seen again by human beings?  If so, can you be sure it exists?  Or will it be on loan to an art museum where could be seen by others and kept safe?  Or is the guy running the scheme putting the painting in his living room and enjoying the ownership value of it while at the same time raking in dollars from duped investors who are essentially paying for his artwork.

There is also the issue of security. This is not an FDIC insured investment. It's not even investment that's listed on the major stock exchanges or sold through a mainstream brokerage house. If the guy selling shares in a painting goes bankrupt, what happens to the painting itself?  Or suppose the painting goes missing, only to be found later on being auctioned off in Europe?  How will the shareholders go about retrieving their painting?

But underlying all of this is the volatility of the art market.  Collectible items are really a silly investment, whether it's for the very poor or the very rich.   If you're mega-rich, you can spend millions on a painting and it really doesn't affect your net worth very much.  But often these paintings aren't very good investments - nor are collector cars, or collector anything.

fairly recent article in Wall Street Journal analyzes this aspect of the problem.  Some art collectors are approached by auction houses to provide backstop bids for paintings. Often these are bids well below the estimated auction price.  The bidder guarantees this bid for a fee, thinking that either way they win.  Either they get paid to do this backstop bid or they end up buying a piece of art at a bargain-basement price.  But what often ends up happening is they end up stuck with a painting they didn't want to buy and now they can't unload at any price.  There are number of paintings that are making the rounds going from auction to auction, and either not being sold, or going to guaranteed minimum bidders.

When economic times get tough, things like collector cars and collector paintings and collector Elvis plates drop in value precipitously. We saw this with the price of Ferraris during the boom and bust.  During the boom times every new wunderkind wanted a classic Ferrari and drove the prices through the stratosphere. When it all fell apart, these cars flooded the market at bargain-basement prices.

So buying art or classic cars or any of these other types of collectible items is a risky venture to begin with.  Buying shares of such a risky venture is taking that risk and multiplying it by a factor of ten, a hundred, maybe even a thousand.  It is like the difference between owning a house or a condo - the value of a share of a building is more volatile than the value of a building.

The only person who is going to make money in this deal is the guy buying the piece of art, jacking the price up and then selling off shares of it.  It's a clever idea for the guy in charge - a stupid idea for anybody who wants to "invest" in this nonsense.