Using Royalty Exchange: Investing In Music Royalties

While looking into the concept of buying existing websites for income, I came across a way to invest in music royalties through a company called Royalty Exchange.  I like the concept of owning intellectual property because there is the potential for it to continually provide income for life plus 70 years of the content creator.  Within this industry these assets are traded in closed markets between individuals.  This keeps prices low and keeps 99.99% of potential investors out of the loop.  Royalty Exchange is trying to change this by offering a marketplace for people to sell their intellectual property to potential buyers.

How Royalty Exchange Works:

The vast majority of properties offered on Royalty exchange are rights to music royalty streams.  I have seen the rights to 1 book and the rights to large collections of images for sale.  In general copyright law allows the owner of the rights to receive income on the property for the lifetime of the creator plus 70 years.  Most of the listings on this site are set up with these terms however some are for a flat 10 year term.

Risks Of Investing In Music Royalties Through Royalty Exchange:

  1. Music Depreciates Quickly: Music royalties are fleeting.  Often after the first couple years they can drop by 75% or more and continue a steady decline.  It is rare for music to continue produces strong income for 10, 20, 30 years or more. This makes the tail end of the copyright term potentially not worth much.
  2. Not Diversified: While browsing through completed auctions many of the song collections offered will state in the description how much income is derived from 1 song.  Generally collections of dozens of songs earn the vast majority of their income from 1 song.  Other auctions are for single song royalty streams.
  3. Seller Buyback Options: Some auctions have a clause allowing the seller to buyback the property within 1 year. This gives the buyer a quick return on investment, but ensures that if the property increased in value the seller would snatch it back.  I would be very hesitant to buy one with these terms.
  4. Limited Market to resell: How many people do you know who buy music royalties?  Exactly.  Royalty exchange claims to have over 22,500 bidders (I’m one of them), but this is hardly a large market.  There are hundreds of millions of people who buy and sell stock in companies.
  5. Marketing Risk: What if no one is selling the product?  You don’t have the rights to make deals on the song when you purchase the royalty rights, you only have access to the income generated.  For this reason you want to look at owning only partial songs so that the artists and recording companies are retaining skin in the game to continue to sell the product.

Royalty Exchange charges a fee to both buyers and sellers.  Sometimes the fee is as much as $500 for the winning bid and sometimes the fee is a recurring $99 per year for administrative fees. With the $500 fees being charged they are often associated with the seller and not Royalty Exchange itself.  For example if you are buying a property offered by BMG you pay a $500 for the first property you buy, but then any subsequent royalties you buy from them will not have this fee.

How Do Music Tracks Make Money?

The primary ways that music tracks make money is through radio play, streaming, and tv/movie/commercial play. For each auction Royalty Exchange publishes a chart showing how much money the royalties have earned over at least the past 12 months and it is often accompanied by a breakdown of where these royalties come from. The fluctuations between quarters and years can be very large.

Royalty Exchange Opportunity: Long Term Cash Flow:

I think that overall humans are really really bad at thinking long term.  This is evident in the historic prices paid for these music royalty assets.  I’ve looked at all the completed auctions in the Royalty Exchange catalog and I find it very interesting that 10 year royalty streams seem to sell around 5X last years revenue, while lifetime plus 70 year tracks tend to sell at 8X last years revenue.  I believe this is more than just a discount based on depreciation, this shows that the average bidders are not thinking long term.  In addition to owning the rights to property for longer than my natural lifespan I also like the fact that it seems many of these properties are undervalued due to the combination of short term thinking and a very small market at this point in time. You can view all completed auctions and their financial details when you sign up for a free account at Royalty Exchange.

Why Would An Artist Allow You To Invest In Music Royalties:

The problem for recording artists is that their income often can’t be borrowed against so for major purchases they may decide to sell off either all of their rights to a song, or part of their rights to a song to generate cash now. Record labels also will sell off music they own rights to when it no longer fits with their current strategy. Sometimes artists want to retain the long term potential to their songs so they will sell their royalty stream for 10 years rather than the full copyright term, or better yet they will keep a percentage of the ownership which is great for a buyer because then the artist has skin in the game to keep finding more ways for the property to earn money.

Fees Involved: Often there is an end of auction fee as well as a yearly distribution fee.  These fees make lower priced auctions less appealing.  If an asset brings in $600 in cash flow per year, but you have to pay $100 per year as a distribution fee you are paying in my opinion way too much in fees. Because of the fees associated with music royalties higher valued properties tend to make more sense.

Investing In Royalty Exchange Through An IRA:

Currently the vast majority of my money is tied up in home equity or retirement accounts.  All my free cash flow is earmarked towards paying off the house so if I wanted to invest in music royalties sometime in the next 3 years I would need to do so through my IRA.

Yes, you can invest in music royalties from Royalty Exchange through an IRA, but there is a catch.  It has to be a self directed IRA and chances are you don’t have one of those.  A Self directed IRA will allow you to buy all sorts of alternative assets inside of it such as real estate, businesses, and even music royalties.  Self directed IRAs have much higher fees than normal IRAs like you get from Vanguard or Fidelity.  For example at Madison Trust Co.  A self directed IRA costs $99 to open, then $49 per quarter for a maintenance fee and $50 per transaction.

These fees are a large percentage if you only have a few thousand dollars to invest. A $5,000 asset producing $700 per year would be mostly absorbed by fees from the IRA and Royalty Exchange.  It only makes sense to invest through an IRA if you have tens of thousands of dollars to invest so that the percentage of the fees is relatively small in comparison to the income.

Does It Make Sense To Invest In Music Royalties In An IRA?

Just because you have money in an IRA and are allowed to invest through an IRA doesn’t necessarily mean that it’s a good idea.  I’ve written extensively on how to get around the age 59 1/2 rule with IRAs, so we don’t need to worry about the limited access to the money, since we can set up an SEPP when we are ready to enter early retirement. With an SEPP you do accept certain restrictions, such as not being able to change how much you are taking out per year and you have to got through some additional paperwork every year. The main purpose of an IRA is to shield current growth from capital gains taxes.  Overall music royalty properties are depreciating in nature so that benefit is largely not needed.

If you invest outside of an IRA you are creating an immediate passive income stream that you have access to now without having to file for an SEPP.  You also wouldn’t file for an SEPP until you have a very substantial income available because you aren’t able to change the amount.  Investing outside of an IRA allows you to build up your passive income stream gradually and replace your active income with it as you see fit.

For example, If I invest $50,000 in music royalties and I paid 7X last years earnings for the royalty stream then it is possible that in the following year I would have somewhere between $6,000 and $7,000 in royalty income.  With this income we would have the flexibility for Mrs. C. to substantially reduce her hours at work.

From an SEPP standpoint if $50,000 represented 25% of our total retirement funds then on a $200,000 portfolio at age 35 using the SEPP Required Minimum distrubition method, then we could withdrawal $200,000 / $48.5 = $4,123.  Not only is this amount substantially lower, but if I wanted access to the cash now I would have to take an SEPP and would be stuck with this distribution amount for at least 5 years.  If my music royalties were outside an IRA as I increased my royalty stream I would have access to more cash this is still beneficial even if I am reinvesting that cash because having the option to reduce current active income is highly important.

If I Don’t Use An IRA What Are The Tax Implications?

The taxation of music royalties, as long as you are not the creator are taxed as ordinary income.  This has some advantages and disadvantages.  For creators it is seen as self employment income and self employment taxes would be due from the royalty income generated.

The biggest disadvantage is that having current investment income can cause you to miss out on tax credits.  Let’s say that Mrs. C. and I are able to live comfortably off of $36,000 per year and in 5 years when we have 3 kids in the house and our home is paid off our income mix is $30,000 from my work and $6,000 from royalty income.  In this scenario we would completely miss out on the earned income tax credit because we have over $3,500 in investment income.  For a couple earning $36,000 with 3 kids we would otherwise receive a refundable tax credit of $3,862.  This is tax free money that we would have to do nothing for.  This gives a bit more credence to putting the royalty income in an IRA.  Another option would be waiting until the kids are grown before investing in royalty producing assets.

I’ve had conversations before where I have been criticized for encouraging early FI or semi FI people to take the earned income tax credit.  This is because many people believe that the intent behind the program is an anti-poverty measure for poor people.  This simply is how the tax law was written.  “poor” Vs “rich” is a measure of wealth, while “low income” vs. “high income” is a measure of income.  This tax credit was purposefully written for low income and purposefully does not have an asset test like many social programs do like medicaid, housing assistance, food stamps, and cash assistance, often depending on which state you are in.  This is how the tax code was written and I firmly believe that each individual should do what they can to use the tax code to reduce their taxable income.  Using the Earned Income Credit is no different than a high net worth individual receiving a tax deduction for 401K contributions or a tax deduction for mortgage interest.

The 2nd disadvantage is that capital gains and qualifying dividends on assets held for over 1 year are taxed at a 0% bracket if you are in the 15% tax bracket.  Royalty income does not receive this tax treatment. To me this is a glaring mistake in the tax code and royalty income should be treated exactly the same as qualifying dividends, but it isn’t so we have to plan accordingly.  When you sell a royalty producing asset the sale will register as a capital gain or loss and will receive the same tax treatment as any other asset.

On the positive side music royalties are considered a depreciating asset. Amortization of intangibles is covered by sections 197 of the IRS code of 1986. Very similar to depreciating the value of a rental house you can depreciate the value of the royalties you own. From my brief reading of the tax code it looks like the depreciation should be done over a 15 year term.  If you fully depreciate an asset and it is still earning money at the end of that term then any proceeds from a sale would be a capital gain.

The other really big positive to owning music royalties outside of retirement accounts is that the income is current and generally substantially higher than income from dividends, bonds, or rental real estate compared to the value of the asset.

Types of Music Available Through Royalty Exchange:

Sometimes it is single tracks that are sold and sometimes a recording studio will sell a portfolio of unrelated tracks.  Background music to television shows and even theme songs to TV shows comes up for sale.  Recently a collection of tracks including Elmo’s World sold for $580,000. For auctions with a $500 buyers fee this is a one time fee paid to the recording company to set up your account, you only have to pay this once so subsequent royalty purchases will not include this fee.

Single Tracks:

Auction 1:  Alabama If You’re Gonna Play In Texas: Life Of Rights:

  • Last 12mo Earnings: $4,992
  • Closing Price: $56,000
  • Buyer Fee: $500
  • Last year earnings / sale price: 8.9%

Last year royalties for Alabama’s “If You’re Gonna Play In Texas” came up for auction.  This auction was for 25% of the life of rights income stream to the song.  In the last year these rights earned $4,992.  The auction closed at $56,000. This song I believe commanded a premium based on its longevity.

Auction 2: Alabama If You’re Gonna Play In Texas: 10 Years:

  • Last 12mo Earnings: $4,613
  • Closing Price: $25,000
  • Buyer Fee: $500
  • Last year earnings / sale price: 21.5%

This year royalties for another 25% of the song came up for auction, but with only a 10 year term.  Since we have the exact same musical property this gives an EXCELLENT comparison for 10 year Vs Lifetime terms.

Auction 3: Dr. Dre What’s The Difference: Life of Rights

  • Last 12mo Earnings: $5,453
  • Closing Price: $47,000
  • Buyer Fee: None
  • Last year earnings / sale price: 11.6%

Auction 4: DJ Khaled and Drake For Free: Life Of Rights

  • Last 12mo Earnings: $15,651
  • Closing Price: $44,500
  • Buyer Fee: $500
  • Last year earnings / sale price: 35.2%

This track appears to have sold at an extremely low value compared to the other tracks, but this is largely due to how new to song is.  Alabama released If Your Gonna Play in Texas in 1984, Dr. Dre released What’s The Difference in 1999, For Free was released in 2016.  The low sale price to previous 12 months earnings represents the quick downward trend of recently released music.  While the past 12 months have earned $15,651 there are only 5 quarters of data available and the first quarter was a small partial quarter.  The most recent quarter only saw $1,756 of income.  Multiply this by 4 and you have earnings of only $7,024.  This would give an earnings to sale price ratio of 15.8%. It is highly importnant to look at the previous earnings data to see the velocity of change in earnings, especially for newer music.

 

TV Production Music:

Individual tracks are more likely to carry an emotional premium to them.  I think a lot of people think its “cool” to own a certain song, and I have to admit I would love to have “If You’re Gonna Play In Texas” come on the radio and tell a friend I just got paid!  Production music isn’t as sexy.  Production music is the background music and intro music you here on TV programs.  No one can name the title of the track or the artist, it’s just there to break up the dead air.

Auction 1: 10 Year term:

  • Last 12mo Earnings: $1,818
  • Closing Price: $8,050
  • Buyer Fee: $500
  • Last year earnings / sale price: 22.6%

Auction 2:Life Of Rights: 20% of a large catalog.

  • Last 12 mo. Earnings: $5,299
  • Closing Price: $38,500
  • Fees: NONE
  • Last year earnings / sale price: 13.8%

Auction 3: Life of Rights * Same catalog as above, 20% of catalog

  • Last 12 mo. earnings: $6,232
  • Closing Price: $32,500
  • Fees: $250 Buyer Fee + 5% Admin Fee of Royalties paid per quarter
  • Last year earnings / sale price: 19.2%

Auction 4: Life Of Rights

  • Last 12 mo. Earnings: $16,783
  • Closing Price: $90,500
  • Buyer Fee: $500
  • Last year earnings / sale price: 18.5%

 

Non Traditional Music / Other:

Auction 1: Sesame St:

  • Last 12mo Earnings: $108,500
  • Closing Price: $540,000
  • Buyer Fee: $75
  • Last year earnings / sale price: 20.1%

Sesame Street: In 2017 a catalog of songs came up for auction that produced $108,500 in the past 12 months.  The 2 main songs were “Elmo’s World” and Abby’s Flying Fairy School from Sesame Street.  Sesame street continues to make new episodes and reruns are played all the time.  This type of property has some build in longevity.  The auction ended at only $540,000.  Now I can’t see a point in time in my life where I will be able to invest $500,000 in music royalties, but overall I think this was a heck of a deal. This auction came with a $75 buyer fee.  The writer has already passed so the term of this auction is for the 64 remaining years the music has under copyright.

Auction 2: Stock Images /videos

  • Last 12mo Earnings: $41,004
  • Closing Price: $175,000
  • Buyer Fee: None
  • Last year earnings / sale price: 23.4%

This auction was for a 33% stake in a stock video / images catalog.  The original owner is retaining a 1/3 share of the catalog to keep skin in the game, which is great for the buyer to know that someone will be trying to maximize income from the property.  There are thousands of videos in the catalog with no 1 video producing a substantial portion of the income.  Unlike with the music financials, this catalog is not showing a downward trend in earnings.

My Thoughts on Using Royalty Exchange to Buy Music Royalties:

My thoughts: I think this is certainly an interesting asset class to be involved in.  I don’t like that there are very limited offerings, which I think keeps the prices higher than what they would otherwise trade at.  Currently Royalty Exchange only has 5 auctions going.  In a healthy market I would like to see dozens, if not hundreds of auctions occurring at the same time.  I think Royalty income should play a part in everyone’s portfolio however I would put investing in Royalty income after paying off the house and funding retirement accounts. I think having a collection of diversified income streams in retirement and early retirement is ideal and music royalties play a part in this.

For me personally I plan to revisit investing in music royalties directly after paying off my house in the 2021 – 2022 time frame.  I will potentially invest somewhere between $5,000 to $10,000 per year and reinvest all dividends for 10 years, at which point the total portfolio would be capable of covering a decent part of our expenses.  In total I think Royalty investments will peak somewhere around 5-10% of our total net worth.  I think that music royalties are a great source of income for early / semi retired people to use while letting their traditional nest eggs continue to compound.

What do you think of Royalty exchange and investing in music royalties? 

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John uses the free tool Personal Capital to track his net worth and posts quarterly updates on his finances. Check out the Action Economics archives section for all past posts.

Leave a Reply

Your email address will not be published. Required fields are marked *