Are property fair value adjustments really fair?

By Admire Mavolwane



THE budget presentation is always an event to look forward to. Not that we are fascinated by the famous briefcase photograph. Neither are we excited

about the budget proposals but of late the budget presentation has come to be about the only occasion when some reasonably recent statistics on the economy are made public.


However, a story carried by the Herald of November 21, in which the Minister of Finance is reported to have admitted that line ministries have not been submitting returns for the past six years, does not make good background reading for budget day.


In essence, the Treasury knows only what the ministries have been allocated, but is not in the picture as to how much has been spent and how much, if any, has remained in the kitty.


He is also in the dark as to what happens to the leftovers. In short, the books have never been balanced and the accounts/year-end financials have not been signed off for over half a decade. We are, in a way, not going into the 2007 from a position of strength, house keeping wise.


As a recap, this is what the minister said in his half-year fiscal policy statement with regards to GDP growth and the budget deficit.


For the second half of 2006, $140 billion (revalued) was expected to be collected, against an expenditure target of $327,2 billion. In other words, he expected government to spend 2,3 times more than it would have collected. This means that the budget deficit for this period would be $187,2 trillion.


By our calculations, the budget deficit for 2006 would have amounted to 24% of GDP. Our figures excluded parastatal losses and other quasi-fiscal expenses, which have not been comprehensively quantified as far as we are aware, for a very long time. We will review the 2007 budget proposals next week.


Moving away from the budget, last week we made remarks about the investment market’s discomfiture with the liberal and sometimes aggressive application of accounting standards IAS41 and IAS40.


The former set the guidelines for the estimation of the value of biological assets while the latter pertains to the revaluation of physical properties classified as investment properties.


The difference in application is that the IAS41 is in the domain of management and as long as the external auditors are happy with the method of estimation it can be applied. For investment properties, professional property valuers are roped in.


The issue that has come up with regards to IAS40 is that many in the market are of the view that the property revaluations are rather excessive especially when compared with the familiar bench marks; US Dollar and the CPI indices, both official and independent.


For example, listed property entities Mash and Dawn in their financials published yesterday did push through their income statements, property fair value adjustments of over 4 000%.


By comparison, the year-on-year CPI inflation for September 2006 was 1 023,3% and the parallel market devaluation of the local unit of approximately 2 000%.


It is rather unfortunate that the CSO is no longer publishing the building materials index which would have acted as another crude benchmark. Maybe at some future occasion the Real Estate Institute of Zimbabwe will organise a workshop to educate the market about the methodologies applied in arriving at property values.


We now turn to the actual results. Mash’s turnover, which can be appropriately termed rental income, went up by a sub-inflation 858% to $200 million, mainly on account of the structure of the lease agreements.


Strong performance in the “other income” line item from $14 thousand to $30 million, outpaced both the growth in cost of sales of 1 824% to $43 million and the 805% growth in operating expenses to $94 million. This saw operating income before revaluations increasing ten fold to $94 million.


Then came the contentious 4 345% growth in the value of the property portfolio to $35,8 billion, which saw a colossal $34,4 billion fair value adjustment being booked through the income statement.


Added to finance income of $85 million and $640 million arising from the fair value adjustment of equities it greatly boosted the growth in the bottom line. Attributable earnings of $24,4 billion were, in the end, realised meaning that Mash shareholders are 4 974% wealthier than they were in 2006.


Not to be outdone, for the six months to 30 September 2006 Dawn also booked in a huge fair value adjustment. Unlike Mash, though, rather than use external valuators the directors of Dawn did an internal valuation. The outcome was a $88,8 billion appreciation in the value of their properties with the same figure finding its way into the income statement.


Revenues grew 35 times to $300 million, driven mainly by the commissions from the recently acquired CB Richard Ellis. Of this amount, rental income, which is tied to Zimsun’s turnover, amounted to $83 million.


Finance income of $17 million, coupled with other adjustment gains of $56 million, saw attributable earnings of $61 billion being realised.


In the aftermath of the results, the market seems to have believed the numbers from Dawn, especially the contribution of CB Richard Ellis and buyers were keen to add the counter to their portfolios.


Consequently, the price gained $2 to $40. On the other hand, it appears some investors were keen to exit Mash, with the counter being offered at $40.