Art Valuation

Since the early modern periods, art has been a sign of wealth. Artists painted portraits of the monarchs who used to display the paintings on their castle walls to show their power, wealth, and honor. 

The contemporary art market is made up of a lot of movable parts and components in both the real and the online realms. 

However, if you strip it down to its most fundamental elements, you'll find that it requires an interested buyer, a willing seller, and the art piece being offered for sale.

However, for any transaction to take place, there is one more essential component that must be present: an agreement over the worth of the labor. 

Therefore, it should not come as a complete surprise that the discipline of art valuation has flourished in tandem with the art market's expansion.

Art is an asset

The wealthiest individuals get to hang on their walls the most famous art classics. Yet, the purpose of buying art is changing as the world evolves. The art market is the marketplace where buyers and sellers trade art. 

Like any other commodity, like real estate and stocks, art is an asset. The price of artwork varies in tandem with market fluctuations. Art can be bought for aesthetic value, used as an ornament, and traded like any other financial instrument. 

Art valuation estimates the market value of works of art. It's more of a financial than an aesthetic concern, yet subjective cultural values have a role.

Art valuation requires analyzing data from auction houses, private and corporate collectors, curators, art dealer activities, gallerists, professional advisors, and specialized market analysts. 

Art value is done for collection, investment, divestiture, finance, estate valuations, charitable contributions, tax planning, insurance, and loan collateral. This article discusses the valuation of high-end fine art, especially contemporary art, but similar ideas apply to less expensive art and antiques.

The valuation of art is linked to the art market and its dynamics. The art market consists of primary and secondary art markets. Once a new piece of art sells in the primary market, it enters the secondary market. 

The valuation of the piece becomes harder because contemporary artworks need historical data. So the predictive analysis becomes more speculative. For example, the price of a well-known Renaissance painter is different from the price of a painting by any other artist.

It is hard to estimate the price of an unknown artist's painting or whether it will sell at all. So, when the historical data of the artist, previous owners, and classification are available, the valuation becomes easier, especially when there are similar pieces in the market. 

Only then will the buyer be able to make an informed decision by considering the necessary insights related to the artwork. Everybody has different purposes for buying art. Nobody has the same taste, and nobody has the same appetite for risk. 

Some individuals will be willing to pay a premium for certain artworks. Especially when there is an emotional value or the painting uniquely impacts them. Each artist's painting has its unique cachet, and each person is affected differently by the same piece. 

How much are individuals willing to pay for the artwork?

Everyone comes from a unique cultural background and has their perspective on what constitutes beauty. Consequently, the same artwork piece might have different interpretations depending on who you ask. 

Over the past century, the art market has seen significant change. As was just discussed, the motivations behind purchasing art are constantly shifting. The artist Pablo Picasso, for instance, inspires many people who like art to make purchases of paintings. 

While some people buy art to flaunt their wealth or as a safe place to invest money that will eventually pay them handsomely, others enhance their aesthetic experience. Some individuals are prepared to spend millions of dollars on a piece of artwork.

To evaluate this market, the total dollar amount of art sales and the total volume of art sales made in the global fine art market need to be calculated. 

The United States, the United Kingdom, and China account for most of the collectors and buyers of high-quality artwork.

In addition, investors have to pay a substantial fee if they want to join an elite group of art collectors. If a person cannot afford to spend millions of dollars on other n artwork, it is difficult for them to join societies like these. 

Even if the value of art is difficult to quantify, having it professionally appraised is necessary to determine its true market value. 

To assign a correct price to a piece of labor, a knowledgeable person must determine its worth by examining all relevant criteria, including market insights and historical data.

In reality, almost half of the artworks have a fair market value. Others are undervalued or overvalued because the price is perceived subjectively in the art market. The professional will have to conduct extensive research by gathering the data. 

The data includes the historical background of a painting, the artist's reputation, and the materials used. Also, it compares to other similar works on the market. Once the data is ready and analyzed, the experts can estimate price ranges accurately.

You can learn more about specific technical aspects of art valuation by checking out Sotheby's Institute of Art. They are the leaders in art business education and object-based learning. 

What are the factors that determine art's value?

A few factors that determine an artistic work's fair market value include:

• Supply and demand

• Scarcity

• Reputation 

The value of art needs competence in both the valuation and the evaluation of art. Therefore, it is necessary to research several essential aspects. Unfortunately, pricing in this sector is prone to becoming subjective for several reasons.

When establishing the value of a piece of artwork, factors such as its authenticity, signature, condition, size, subject matter, color density, pricing of similar articles, and culturally perceived value all play a significant impact. 

In addition, art's value is intangible, adding another layer of complexity. However, comparing artworks available on the market will reduce the likelihood of making an error in your estimate. 

Even more so, if the artist has eighty works of art comparable to one another or eight paintings that share the same characteristics, there are significant hurdles to overcome to enter the art industry.

Because of the shortage that is caused by the barriers, the already high prices of paintings created by well-known artists are driven even higher. Both supply and demand are important aspects that play a role in determining the value of a piece of work of its rarity.

The value of art, as with the currency's worth, is determined by the collective intentionality of its consumers. 

No value can be derived from the thing itself (no more than that of a hundred-dollar bill). The commercial value is created by human stipulation and declaration, and they maintain it.

Many individuals continue to be shocked or outraged when they learn that a specific piece of artwork has been sold for a significant amount because they believe art does not serve any necessary function. This misconception is the root cause of these reactions.

It serves no practical purpose and does not appear connected to any necessary task. It is impossible to live in, drive, eat, drink, or wear anything made of it. Even Plato believed that the worth of art was questionable because it was a copy of reality.

The importance of scarcity and reputation

Every person's ideal living room would include a work by one of the following artists: Da Vinci, Picasso, Botticelli, Van Gogh, Dali, or Warhol. 

However, because so few of these masterpieces exist, they go for an extremely high price. In addition, the work of art needs to bear the signature of the painter who created it.

The scarcity of artworks makes them more attractive because only a few pieces in the world make them unique and valuable. As a result, the demand increases, and only the ultra-rich can buy these pieces.

It tells a lot about the subject matter and the philosophy behind a given work of art, which adds value and a deeper meaning to it. They would sell for a fortune if the pieces were painted centuries ago by famous artists like 

• Da Vinci 
• Botticelli
• Donatello
• Raphael

A few pieces are left in the world, thus rare. Nevertheless, high net-worth individuals are eager to buy them. 

Everyone buys artworks signed by unknown artists for the lowest prices. Therefore, the art market is for the ultra-rich who can afford expensive art.

After verifying the size of the artwork, an appropriate dollar value per square inch is set. The dollar value assigned reflects the artwork's reputation and actual worth. Perceived cultural value plays a prominent role in determining the price of a piece. 

As a result, high-end clients come back for more. Many rich individuals pay millions to hang a painting on their living room walls. The reputation of an image is predominant, as is the standing of the dealer, the intended purchaser, and the work's size.

Art enthusiasts collect million-dollar paintings because they are passionate about art and want to show off how. Each piece's uniqueness reflects a particular historical area and shows cultural richness. 

Even more so if it was made for a famous king or queen or if a renowned artist painted it from the Renaissance or today. The valuation analysis is also affected by the materials used, especially if the artist used gold or other precious stones.

In some cases, the paintings need restoration. Especially if they are in bad condition or date back centuries and need to be better preserved. So, the price of artwork goes down because its condition is one of the most important things determining its value.

Why is art used as a financial instrument?

Market regulations establish the price ranges at which commodities and financial instruments sell. However, the art market is not transparent; there are no regulations. Also, private sales data isn't available like in the stock market.

Private sales represent half of the market's transactions. As a result, fraudulent activities and art forgery are common. Only wealthy investors and art dealers can buy masterpieces without disclosing their identities. 

As a result, various frauds and money laundering activities take place. Some buy art for tax avoidance and money laundering rather than for its uniqueness. Individuals tend to purchase artwork to launder their money.

Some use art as an ornament, but others use it as a financial instrument. A lot of individuals engage in this market because they want a safe place to secure their money away from taxes. They would rather buy expensive paintings rather than pay federal taxes. 

Tax avoidance encourages wealthy investors to buy because they can preserve their wealth. This market is for a few wealthy individuals who manipulate the prices of artworks to avoid or lessen the burdens of their income taxes. 

By buying an art piece, an investor can store his money as if he purchased any other asset. When the prices of similar artworks increase, the price of his piece also increases. As a result, wealthy individuals are willing to buy expensive paintings.

They know that they will be able to sell them at higher prices. When a painting sells for a premium, the value of other similar works also increases. Conversely, an art piece can lose its value overnight if another similar artwork is sold for a bad price.

Art is a financial instrument and is like stocks, for instance. Of course, there are a lot of risks associated with buying art. 

Yet, there are many ways investors can generate gains from art pieces. For example, they can resell them for higher prices or put them up for auction at auction houses. 

Some prefer to ship their artworks to freeports. For example, some wealthy investors buy art pieces and send them to freeports, where paintings can be sold without taxes. 

Hence, when the prices of similar artworks increase, they can resell them at a higher price and realize gains. 

What is the role of auction markets and galleries?

Christie's and Sotheby's are the leading auction houses worldwide. They display the works of in-demand artists for millions of dollars. High net-worth individuals keep bidding for higher prices because they know it will be worth it.

 If they own several classics painted by the same artist, all the other paintings' prices will increase, too. The galleries keep details about the monetary values private. As a result, the work appears more valuable to the suitors. The reputation of the dealer plays a prominent role.

The collectors and art enthusiasts became eager to add the work to their collection and close the deal. As a result, galleries tend to select and hype exclusive artists of their own choice. As a result, the value of their artwork increases, as well as the demand for such pieces. 

Also, galleries can host prestigious exhibitions and get influencers to write articles about the works of art. Many strategies can help art dealers and galleries sell the artworks of artists. For instance, bidding for the paintings of an exclusive artist they chose to work with. 

Some are willing to bid or even get their friends to bid for the paintings of an artist to boost the price of his works and, as a result, increase the demand. In addition, galleries and dealers can use various strategies to manipulate the prices in the art market and, as a result, generate gains or avoid taxes. 

For example, galleries can influence the art appraisal by getting an expert to re-price the painting at a higher price. Also, investors can donate art pieces to museums to reduce their tax burdens or take them to an auction so that people will bid at higher prices. 

Even artists and dealers can bid for an artist to raise the price of his artwork. After raising the prices, any individual or gallery who contributed gets their commission. To sum up, refined art is for a few wealthy key players who are private about their business. 

The purpose of buying art has evolved, so artworks are not used as an ornament only but as a financial instrument and a means of tax avoidance. As a result, auction houses, galleries, and art dealers generate lucrative returns from art trading.

Researched and authored by Tala Awad | Linkedin

Reviewed and Edited by Aditya Salunke I LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Absolute Valuation
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• Discounted Cash Flow DCF Formula
• Free Cash Flow to Equity (FCFE)
• Leveraged Recapitalization