Can passion assets ever be hardworking, reliable investments?

Luxury assets can be both treasured possessions and valuable financial tools, but it is crucial to consider the potential risks and costs involved.

Luxury or “passion” assets, namely collectible tangible goods with additional personal or emotional value, are often cited as outperforming other asset classes over long periods. Traditionally, returns are realised upon sale, but these assets are increasingly being used as collateral for loans, allowing their value to be liquidated without transferring ownership. However, is this a sensible investment strategy?

When lending against an asset, the lender is entitled to sell that asset if the borrower defaults, applying the proceeds towards the debt repayment. Borrowers must therefore provide evidence that the secured asset is worth more than the debt plus interest. This involves detailed documentation and information to prove the asset’s value and ownership.

Without a standard title document for most luxury assets, proving the exact ownership can be challenging, especially for items held in families for generations where documentation may be scant. Evidence such as auction records, receipts and purchase agreements, or even trust deeds and wills, is crucial. Further, given the inexorable link between the value and authenticity of luxury assets, lenders will require an independent valuation and a chain of title from the present owner back to the creation of the work, together with appropriate supporting documentation, such as gem certificates, trust deeds and catalogues raisonnées.

As alerting the market to the fact that an asset is or may be subject to finance could suppress its value, the valuation must be confidential. Most auction houses will provide these without an obligation to sell.

Mitigating risk

Due to the subjectivity, volatility and lack of comparable values in the luxury assets market, lenders typically mitigate their risk with higher interest rates and lower loan-to-value ratios compared to traditional assets. This cushions the lender against potential losses due to market fluctuations or issues with the asset’s provenance.

UK lenders typically require exclusive possession of the asset, either by holding it themselves or through a third party. Borrowers should expect lenders to control access, storage conditions and use of the asset, severely limiting the borrower’s access during the loan term. Sales, exhibitions, restoration and racing are also usually prohibited without lender consent. This helps to ensure that the asset remains in optimal condition and retains its value throughout the loan period.

Borrowers typically bear the burden of any taxes arising from the loan. In order to avoid unexpected tax liabilities that could affect the borrower’s overall financial position, a thorough analysis of the tax implications – including those related to asset sale, ownership structure, location and import status – should therefore be conducted before entering into the loan.

Finance options

Luxury asset finance is usually provided by private banks or specialist lenders. Relationship-based bank loans are often cheaper but may require additional guarantees and significant assets to be placed under management with the lender. Bank credit and risk requirements can lead to a lengthy, document-heavy process prior to funding, but some banks have used luxury assets cleverly to augment struggling security portfolios or raise additional funds for investment on behalf of clients.

Non-recourse finance, where the lender only has access to the asset, is often provided by auction houses or specialist lenders. These loans are quicker but often come with higher interest rates and less negotiable terms. Occasionally, lenders may offer hire-purchase agreements, transferring ownership to the lender with borrowers retaining possession and use of the asset under a lease (with an option to purchase at the end of the term). But these structures are rare, risky and expensive.

Upon default, the lender will usually sell the asset to repay the loan. To avoid market devaluation – and the perception of a fire-sale – a borrower-led sale with lender consent in the background is preferable. Disputes may arise, however, if the borrower perceives the sale price as too low, potentially leading to legal action. Lenders should therefore rely on independent valuations and consider their duties as security holders before any enforcement sale.

Luxury assets can be both treasured possessions and valuable financial tools when used wisely. By understanding the complexities of ownership, valuation and the various financing options available, investors can make informed decisions balancing both personal enjoyment and financial gain.

However, it is crucial to approach these investments with caution, considering the potential risks and costs involved. Ultimately, the decision to leverage luxury assets should align with a borrower’s overall financial strategy and personal goals, ensuring that these cherished items continue to bring joy and value in multiple ways.

This article was originally published by Professional Wealth Management, click here to read.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, September 2024