Thoroughbreds: A bubble market that continues to race

Where have all our bubble markets gone?
The internet boom has long past and the housing market is about to experience what some foresee as a soft landing and others a hard crash. But there is one market that continues to rally against all logic – the racehorse market.

On Monday, September 11, the Keeneland Yearling Sale, the largest sale of thoroughbred racehorses in the world, will begin in Lexington, KY. More than 5,000 horses will go through the ring during the sale’s 14 days. It is the premier sale of thoroughbreds in the world.

This market has experienced amazing growth in the past five years. The mean price for a thoroughbred has risen an incredible 60% from $25,000 in 2001 to $40,000 in 2005. While the average price reached a record high of $108,420 at last year’s sale which included a sale topping colt that sold for $9.7 Million.

These prices, mind you, are for unproven one year-old thoroughbreds that have yet to run a race at the track. All a buyer can do to evaluate these horses is to review the pedigree page printed on one of the seven catalog books given out by Keeneland to prospective buyers and to inspect the horse’s physical attributes. It is a little like drafting 8 year-old boys to play as adults for NFL teams - it’s all guess work at this stage!

But this market is an international melting pot that brings together buyers and sellers from all over the world and from all walks of life. From kings of faraway lands to small investment syndicates from New Jersey, there is something for everyone at Keeneland. With more than 5,000 horses to be sold, all these buyers come here with the realization that greatness is present - all one needs to do is find it.

Many reasons are given to explain this dramatic increase in prices; one explanation is the increase in the formations of syndicates and partnerships that poll money from smaller investors and provide them access to stock that they would not be able to afford on their own. The benefits of partnerships are many for the individual owner. It allows them to participate in better stock, diversify their investments and reduce their monthly expenses in the upkeep of each horse. These syndicates have attracted a whole new breed of owners who would not otherwise participate in the sport.

In addition, Arbitrageurs, known in horse racing as “pinhookers” have become more active in the yearling sales. They purchase yearlings and sell them the following year in sales for two year-olds in training. At these two year-old sales buyers have the advantage of seeing these very young horses run at speed for a short distance and any hint of ability can skyrocket a horse’s value into the millions of dollars. Early this year a two-year old in training sold for $16 Million Dollars at one of these sales and it is not extraordinary for some of these pinhooking operations to boast an average return of 18% or more on their websites. With returns such as these, more and more players are involved in this activity and dreams of hitting the next homerun keep them pushing the prices of yearlings up.

Other reasons are more extrinsic to the sales: the high price of oil, the strength of the markets, the weak dollar that attracts international buyers etc., but few of these reasons, if any, have to do with the earning potential of the racehorses themselves. The realities of the sport are that purses at tracks are stagnant and on-track attendance is at an all time low. With the exception of a few regional programs that are successful and the promise of video lottery terminals at some tracks; the prospect for horses to earn back their purchase price at the track remains bleak.

The other avenue for return of investment for buyers is the value of their prospects for breeding. Prices of stallions and mares have been rising at an impressive pace. As an example, in 2002 Came Home retired with a stud fee of $40,000 as the most expensive stallion to retire that year. In 2006 Ghostzapper retired at $200,000, a fee usually reserved for the very best stallions whose progeny has proven time and time again that they can run with the very best. The value of these fees pushes the value of stallions to the stratosphere and the price of well bred yearlings has risen accordingly. But the reality is that of the thousands of yearlings that go through the ring, only a handful will be worthy enough to stand at stud.

Females have also increased in value in the past few years dramatically. A great number of fillies purchased at this sale retire after racing to continue their careers in the breeding shed. Their prices, as well as the prices for Stallions, rise and fall in relation with the prices of yearlings. When the yearling markets are hot, breeders are able to pay more for breeding stock and stud fees and their prices rise accordingly. It is a cycle that artificially creates high prices in every sector and creates the problem that when one of these sectors suffers, they all follow suit.

Thoroughbreds are a high-risk game that can offer high rewards, both financially and emotionally, but the game is becoming more and more expensive to play and there is no apparent good economic rational to explain this. But as the Keeneland sale opens its doors, the world will hold its breath and open its pocket books wider than ever in search of the next Derby horse regardless of the price.