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Makumbe bids for NDH Equities

A quick analysis of the financial results of the listed property concerns — Pearl and ZPI — shows that the companies booked huge revaluation gains which they accounted  for as ‘’fair value adjustment’’ in their income statements.

Zimre Property Investments (ZPI) recorded US$7,748 million in property revaluation gains out of a total profit before tax of US$9,054 million, representing more than 86% of the company’s income and 22% of the opening book value of its property portfolio of US$35,448 million. 

Similarly, Pearl Properties booked unrealised gains of US$19,770 million on its investment properties, out of a profit before tax of US$24,884 million, representing a massive 80% of profits and 23% growth on the opening book value of the property portfolio before additions, new developments and disposals and improvements to existing properties.

In both cases, there are relatively low expenditures in either new developments or improvement of existing properties, which in the normal course of business should result in improved property values.  So what exactly, besides ‘’inflation’’ is behind these magnificent growth rates?

For want of a better understanding, ‘’inflation’ here is used deliberately to highlight the ‘’official inflation’’ which closed the year at 4,9% year-on-year in December.

One would have been reasonably happier with the property portfolios being “inflated” at that sort of level, but alas, our property companies do not see prudence. In the immediate prior year ZPI booked fair value gains of US$4,477 million on its property portfolio whilst Pearl recorded another US$11,791 million. Once again, the huge growth rates seem to have little justification besides making the income statements look impressive.

A closer look at the cash-flow positions of the two companies shows that there is a deliberate effort to make the numbers look spectacular.

ZPI’s cash-flow from operations was a negative US$1,043 million which was largely funded by short-term borrowings of US$1,384 million plus US$450 000 realised from the sale of investment property.

To drive the point home, there is no capital gains recorded on the sale of property, a development which raised the possibility that the disposals may have been done at a capital loss. Despite these facts, ZPI goes on to pay a dividend either from borrowings or from the proceeds of sale of investment property, both sources of funds  which would be deemed highly inappropriate for the purpose, given the nature of business. Ideally, prudent companies would judiciously pay dividends from surpluses in operational cash-flows.

In contrast, Pearl does have the cash reserves to be able to pay the dividend from surplus cash from operations. The fair value adjustment does significantly dress up the income statement and of course, the balance sheet. 

ZPI Property Manager Stephen Kapfunde concurred that the valuations were high, but were justified as they had been done by independent experts.  He argued that the valuations were supported by market data on actual sales of comparable properties bought and sold in the markets as well as by the increasing rental income streams upon which property values depend.

A similar comment was advanced by Pearl Properties management, who argued that the property valuations were supported by a 31 %increase in rentals per square metre.

Given the illiquid conditions in our capital markets, the continued rapid rise in the holding value of properties may inadvertently end up creating an asset bubble in the portfolios of the property companies, spelling doom for investors should a market-wide correction occur.

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