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How to Evaluate an Art Appraisal
Suppose someone offers you a work of art for "investment," tells you it's been appraised at a certain dollar value and that's how much they're selling it for. If you're like most people, you're inclined to believe that since the art's been appraised or has had a formal valuation, that appraised value is a fair price to pay. This is not necessarily the case; art appraisals may or may not have any relation to what would be a reasonable price to pay, often referred to as the art's fair market value (FMV). Fair market value as defined by Internal Revenue Service Publication 561 "is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts." With respect to art, this typically means what informed knowledgeable buyers generally prefer to pay for their art when buying from informed knowledgeable sellers on the open market and outside of retail gallery settings. In order to make sure you're paying a fair price for any art you're considering buying, you have to know how to appraise the appraisal, especially if you're approached as an investor rather than a collector, or the art is being presented primarily as an investment.
To begin with, anyone selling art naturally wants to sell it for as much as possible. If a seller thinks that getting their art appraised will help sell it, then he or she will want that appraisal to be as high as possible. In other words, if a seller can convince an appraiser to appraise high, or they interview several appraisers and pick the one who they think will appraise the highest, the appraisal that the seller ends up getting may well be higher than fair market value. And depending on the wording of the appraisal, it may be really high.
So to begin with, whenever a seller tells you his art's been appraised, the first thing you want do is see the appraisal. Sometimes the seller tells you that he doesn't have an actual appraisal, but rather that an appraiser looked at the art and gave a dollar value. This is not an appraisal. Sometimes a seller tells you that he hasn't had the art formally appraised, but that his asking price is what the art sells for at galleries. This is not an appraisal either. No physical appraisal document that you can hold in your hands and read means that the seller DOES NOT have an appraisal.
In all cases where the seller has an appraisal, get it and read it. Pay particular attention to the purpose of the appraisal and also to the name and qualifications of the appraiser. The appraiser should have experience appraising art, be qualified to appraise art and have no conflicts of interest regarding the particular work of art that's been appraised. The appraisal should contain contact information for the appraiser, a conflict of interest disclaimer and also a statement of how the appraised value was determined.
For example, if the "appraiser" turns out to be a dealer or gallery owner who either represents the artist or sells that type of art, then in the great majority of cases, you're getting a full gallery retail "appraisal" which is not really an appraisal at all. It's simply a statement of current retail value, the current price that a work of art sells for in a gallery setting, not necessarily what you should be paying for it from a private party in a resale transaction. Gallery owners, gallery employees or anyone else directly or indirectly affiliated with the art or artist being appraised have conflicts of interest regarding valuing that art and are inclined to value or "appraise" high. Their "appraisals" are, far more often than not, irrelevant for your purposes.
A similarly irrelevant appraisal is one that's been done for insurance purposes. Insurance value is the amount of money that an insurance company is asked to pay out if a work of art is severely damaged, stolen, or destroyed. That dollar amount is normally full retail plus additional expenses that may be incurred in order to repair or replace the art with an exact or approximate duplicate. An insurance appraisal can sometimes state a value higher than the retail price that the art sells for at a gallery.
As stated above, what you want is a fair market value appraisal. The appraisal must clearly state that the art is being appraised at FMV and not for some other purpose. As mentioned previously, FMV is a dollar amount that a willing buyer pays a willing seller under normal circumstances, or would reasonably be expected to pay under normal circumstances (both with reasonable knowledge of the art and neither being unduly influenced or required to act in any way), not in the rarified controlled environment of a gallery, not in the amount of a potential insurance claim. For example, a painting priced at $10,000 in a gallery may have a fair market value on the open market that's only a small fraction of that amount-- hard to believe, but true!
The price that similar works of art might sell for at auction is generally accepted to be a reasonable estimate or approximation of fair market value (or perhaps somewhat lower), assuming the auction is reasonably well-publicized and that bidders familiar with the art being auctioned are in attendance. At auction, art is generally required to sell immediately with no fanfare or restrictions to the highest bidders. Another good estimate of FMV is the price that a retail gallery might pay for a similar work of art before they mark it up (or perhaps somewhat higher). This "dealer price" is considered to be the wholesale value of the art, and is generally considered a reasonable indicator of a work of art's fair market value.
A private party selling art has no reason to charge retail art gallery prices (and certainly not replacement or insurance value prices); that person has none of the expenses associated with owning or operating a gallery-- expenses that galleries normally price into their art when they sell it. Pay a "fair market value" price for any art that you buy from private parties. That price should generally be as close to the wholesale price, dealer price, or auction value of that art as possible.
Additional tips for evaluating appraisals or selling prices:
* The amount of money that a seller originally paid for art has no bearing on that art's current fair market value. Sellers overpay for art all the time and you as a buyer are not required to compensate them for either overpaying or for their mistakes.
* A work of art that's appraised at $10,000, for example, but that's priced for sale at $5000, is not necessarily a bargain. As stated above, a retail or insurance appraisal can be many times the fair market value of a work of art. Always determine fair market value first, no matter how big a bargain the seller makes you think you're getting.
* Make sure any appraisal you are given is current and has been done within the past three years or so. Art prices fluctuate over time. Appraisals dating from the art boom years subsequent to 2008 (or sometimes even from the art book of the late 1980s), for instance, can easily state a dollar amount well beyond what the art currently sells for.