Many people do not understand buyer’s premiums or even why some 80% of auction houses tack on the charge. What is a buyer’s premium, how is it set, and what does that mean for the buyer, seller, and auction house? Keep reading for that explanation and more.
Auctions are generally exciting but have an air of mystique about them. Most people do not know how they work, except that they facilitate the buying and selling of assets, commonly works of art.
The basic process is usually the same. First, the item to be auctioned must be appraised. The house will then explain to the seller its commission structure and sale conditions and discuss any “reserve” – the price under which the item may not be sold. Further, arrangements may be needed to physically bring the item to auction.
The house will present the seller with a consignment contract, which will list all for-sale inventory, high and low bidding estimates, any reserve, and the auction date.
A few weeks before auction day, most auction houses will publish a digital catalog of offerings and their prices and histories. It is also common for houses to preview auction items, allowing opportunities to view the items in person before the actual auction.
Once the auction is wrapped up, the auction house will send the seller a “results of sale” document listing each sold item’s “hammer price” – the final price at which the item was sold. How each auction house handles payments is up to them. Many will send a check with a final statement including prices and fees.
Let us look at art and real estate auctions:
Buyers should have a catalog weeks before the auction, giving them time to conduct independence research to get a better idea of an item or lot’s value. If possible, buyers should see the item in person before “bidding” at a live auction, which usually involves the hoisting of provided paddles.
A real estate auction is a public sale of a property by a bank, the government, a homeowner, or home builder, with bank-owned properties the most common auction type. Buying a home at auction usually involves reviewing local auction listings such as those kept by the local county recorder’s office.
The winning bidder will need sufficient liquid assets to cover auction and bidding fees and must put down a deposit. Most auctions require the winning bidder to bring a cashier’s check for the minimum amount required. Note that most auctions do not permit financing.
A common fee in all types of auctions, the buyer’s premium is a charge that is in addition to the hammer price of an item or lot. It is often called a “commission” or “service fee,” and the amount is stated in the auction house’s terms and conditions.
It is a mystery to many. However, the additional charge, which is usually a percentage of the hammer price, is generally said to be for administrative costs. Specifically, the premium can go toward expenses such as heating and air conditioning, building rental, employee compensation, auction software, and electronic equipment maintenance. The added charge can also be used to cover auction set-up and catalog creation.
The buyer’s premium is an extra charge, not an extra tax. However, the IRS considers it part of an item’s final sale price, which is taxable.
The auction house sets the amount. Major auction houses such as Christie’s and Sotheby’s are known to charge up to 25% on items, while smaller auction houses usually charge between 1% and 15%.
While some auctions use “commission” as interchangeable with buyer’s premium, the former is often separate and is charged to the seller. In fact, premiums can help reduce the amount of commission auction houses may charge the seller. Thus, sellers are encouraged to use auction houses that charge smaller commissions, ultimately shifting more costs from sellers to buyers.
Premiums are charged by auction houses in the fine arts sector. In a real estate auction, in which the auctioneer is also a licensed real estate agent, property is sold to the highest bidder. A buyer’s premium of 3% to 10% is charged to the winning bidder, with the money going to the auctioneer.
There is a myriad of ways to invest in art, including at auction and through art galleries, art fairs, NFT marketplaces, fractional investing, and art funds.
In addition to at auctions, people can invest in real estate in a number of ways, including through real estate investment trusts, online real estate investing platforms, and real estate limited partnerships.
Since 2000, art has outperformed the S&P 500, returning more than 360%. The alternative investment platform Yieldstreet is capitalizing on that, offering opportunities to grow capital through fractional ownership of a diversified pool of artworks by mid-career and blue-chip artists. Yieldstreet also offers a privately held art fund, which buys and manages art works with the aim of generating returns.
Because property prices and income in the nation have historically outpaced inflation, many investors are also turning to real estate, which has outperformed U.S. equities and fixed income on a risk-adjusted and absolute basis since 2000.
Yieldstreet offers vetted opportunities in commercial and private real estate as well, including a Growth and Income REIT, with investment minimums starting at $5,000.
As alternative investments, both art and real estate are popular ways to diversify portfolios, which helps investors minimize the volatility associated with public markets, and guard against inflation.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially exceptional gains these investments presented were also limited to these groups.
To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
An understanding of buyer’s premiums can help investors decide where to put their capital. Such decision-making might lead investors to art and real estate as ways to diversify their holdings — and generate consistent secondary income.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.