Luxury Asset Lending & Borrowing: Diamond Works (Part 1)
In the last few years, there has been a surge in demand for Luxury Asset Lending and Borrowing.
It seems that wealthy individuals are accumulating more Real Assets rather than have substantial cash on hand and by doing so have opened themselves to cash crunch at times. This means that they are asset rich but cash poor. How does that affect them both short term and long term?
What are the various types of assets?
In terms of accounting, there are Tangible Assets vs. Intangible Assets. There are Current Assets vs. Fixed assets and there are Operating Assets vs. Non-Operating Assets.
For the purpose fo this article, we will narrow down the list to Tangible Assets and Financial Assets. Tangible assets also known as Real Assets are assets that we can physically touch like Real Estate. Financial assets are assets that are mostly of monetary value such as stocks and bonds and similar that don’t really have a physical form (even though share certificates are issued in paper form as well as bond coupons etc…).
Wealthy individuals have realized long ago that their assets, no matter what form, need to keep working for them while they are sleeping and either accumulate wealth by increasing the value of the asset or create an income stream from the asset.
Stocks, bonds and real estate can all increase (or decrease) in value over time, and they can also produce income such as dividend income for stocks, interest income for bonds (from the coupon) and rental income from Real Estate.
What about those investors that have already diversified their wealth into various types of Real Assets?
The large majority of wealthy individuals used to diversify the majority of their wealth into a handful of asset types; stocks, bonds, real estate and a smaller holding of gold.
Can Luxury/Passion assets generate investment returns?
In the last 20-30 years, there has been a surge in further diversification of wealth into a new asset type that is referred to as Luxury or Passion. This type is referred to real assets that are unique and different than the 4 major types mentioned above.
Wealthy Individuals have started investing in Real Assets that they have somewhat of an emotional connection to. Some may refer to it as “beyond reason”. The assets I refer to is Art, Diamonds, Collectible cars, Spirits, Wines, other collectibles. When investing in these type of assets, the expectations (in the majority of the time) is different from the traditional assets mentioned above. The expectations are more of an emotional satisfaction with the optional increase in value of these passion assets over time due to a very important factor called “rarity”.
Can Luxury/Passion assets work like traditional assets?
The common factor between traditional assets like stocks, bonds and real estate and Luxury/Passion assets like Art, diamonds and collectible cars is that all have the potential of increasing in value over time. In fact, Luxury/Passion investment that are chosen carefully, and are acquired for at the same market value as traditional assets (in comparative), will most likely increase in value more than traditional assets over a longer period of time. why? because of the concept of “rarity”.
The only challenging aspect of Luxury/Passion asset is that they cannot generate income like stocks, bonds and real estate.
How can Luxury/Passion asset do produce income like Stocks, bonds and real estate?
The solution is to create a financial mechanism. What does that mean? It means that we use the value locked inside the Luxury/Passion Asset that has increased over time and have it work for us.
Luxury/Passion Asset backed loans
In recent years, the alternative lending industry has seen a dramatic increase in activity. Non bank loans have increased as a direct result of various entities looking to lend money for a higher rate than the bank loans, backed by assets that the traditional banks cannot and do not know how to properly evaluate or liquidate in case of a non payment on the loan. It is an area that the traditional banks see as too much risk and not enough return. These loans are normally non-recourse, meaning the loan is not personally guaranteed by the borrower, rather, it is guaranteed by the asset itself. in the case the borrower does not pay the loan, the lender takes possession of the asset and sells it to recover the balance of the loan amount outstanding.
For those that own unique and rare diamonds and have no plans to sell them in the short or even medium term can borrow money from alternative lenders. Rather than have these diamonds sit in a vault and just increase in value over a long period of time, diamond owners can increase the potential by borrowing money against these diamonds. The money can be invested in other Luxury/Passion assets, business or other diamonds for further growth.
For now, these alternative lending facilities can be expensive and range between 1.5%-3% (or even more) per month, so unless the loan is for a very short period of time, where you are waiting for other money to come in from another transaction and just need a bridge loan, these loans may not be the best solution. As the Alternative Lending Industry develops and grows, so will the amount of lenders. This will help bring down borrowing costs. one of the reasons to use diamonds as collateral for loans is for investing in other projects. Sometimes you may not have the cashflow needed by traditional banks to justify a bank loan so you have to resort to your Luxury/Passion assets for loans.
typically the alternative lender will loan a certain percentage of the value of the Luxury/Passion asset. The lender will use an expert to evaluate the item and will help the lender decide on the amount to be lent. Normally the same expert will also be the point person who will help facilitate the liquidation of the asset in case of a non payment in order to recover the loan.
The expert must know the market for such an item both demand and supply as well as market value. The question then is what market value will be relevant? retail? wholesale? firesale?
Let’s leave more information for our next chapter discussing Luxury/Passion Asset Lending & Borrowing: Diamonds Works (Part 2).
In the meantime, if you have more questions or need our help in getting an alternative loan, please feel free to contact us.
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