Holding Costs & Rates of Return
In May 2023, Jacqui Safra, made history when he auctioned the oldest complete Hebrew bible through Sotheby’s. The Codex Sassoon, believed to be 1,100 years old, sold for $38.1 million. It is one of the most expensive historical documents ever auctioned.
As I discussed the sale, one of my new students, Dante, reacted, exclaiming he wished he would win the “lottery” like Safra did.
I asked Dante what he meant and pushed him a bit. I asked what he thought Safra’s rate of return had been for the document. Dante said he did not know, but guessed it was huge.
To help Dante evaluate this I added that Safra bought the Codex Sassoon in 1989 for $3.1 million. Dante grabbed his financial calculator and determined the document increased more than 12-fold over 34 years. The annualized return was 7.7%.
Dante stopped and asked, “Is that good?” Instead of approaching this as a lottery ticket, Dante was now thinking critically about the antique as an investment.
With research, Dante said the US Stock Market produced a 10.3% annualized return over the same period.
Obviously, 10.3% is better than 7.7%, but the compounded difference is extremely difficult to conceptualize. As such, I asked Dante to calculate the dollar difference if the same amount was invested for the same time frame.
Dante ran the numbers, but paused. He was unsure of his answer. The same amount invested in stocks for the same time would have grown to $87 million!
Dante was astonished by the nearly $50 million difference. He no longer saw the Codex Sassoon as the greatest windfall of all time.
I asked Dante if this was all that was needed to compare the investments.
To prompt him, I asked my budding scholar if he would just pay $3.1 million to acquire the historical bible or would he seek expert assistance like an appraisal? Obviously, he wanted an appraisal.
Then I asked if he would just leave the Codex laying around his apartment propping up his unbalanced bookcase? He quickly said he would keep it in a climate controlled storage under lock and key.
Next I inquired if he thought insurance on a rare and valuable document would be wise. Again, Dante agreed.
I said I had no idea what these holding cost amounted to, but they are real expenses that lower the rate of return.
My final question for Dante had to do with liquidity.
I asked how hard it is to turn stock market assets into cash. He had enough experience to know a stock portfolio could be quickly converted to cash every business day in a very low-cost, streamlined manner.
I asked for his thoughts on the liquidity for the ancient bible. Dante knew Safra spent months working with Sotheby’s getting ready for auction. Dante now understood there was a considerable process to convert the text into cash. Additionally, Dante realized that for Sotheby’s efforts, they charged a 10% commission.
This discussion applies to virtually every investment evaluation.
You must understand what things cost and what they can be sold for. It is highly deceptive to simply look at the cumulative change from purchase price to selling price. You must know the annualized return.
The smart investor also understands “opportunity cost.” If you allocate money in any manner, you are effectively saying this is the single best use of funds. A bit of research on historical returns over different time frames is very useful for framing your evaluation.
Furthermore, whether commissions, storage, management fees, maintenance, insurance or property tax, all assets have holding costs. This is the most often overlooked aspect we see with real estate. As a rule of thumb, real estate must overcome at least 5% in annual holding costs before you ever begin making a profit.
Additionally, there are issues of liquidity and taxation. Shares of Pepsi can be sold any business day with few frictional expenses. Conversely, selling real estate or a private business can be very time consuming and expensive.
However, the benefit of forced patience from holding illiquid assets is often overlooked. Applying the same patience to liquid assets will deliver enhanced results.
Lastly, taxes matter. Different asset classes and cash flows have various levels of taxation. Some are favorable while others can be quite challenging.
Dave Sather is a Certified Financial Planner and the CEO of the Sather Financial Group, a fee-only strategic planning and investment management firm.