Harvey Norman booked $107 million in income from property this year -- here's how the accounts work

Photo: Richard Kendall/Getty Images

An increase in the value of Harvey Norman’s property portfolio contributed $107.38 million to its net profit before tax in the 2017 financial year.

That followed a rise of $47.79 million increase in FY16, which itself was a significant increase over the $7.604 million increase the year before that.

How the property portfolio is valued is explained to some extent in the company’s financial statements. The company doesn’t list each property individually in its annual report, but the available information — and the process by which the values are calculated, which includes an assessment of the property portfolio by the board — contain some interesting trends.

The investments in property have been helpful to the company’s performance in recent years.

While Harvey Norman always clearly states its profit figure net of property revaluations in its annual accounts, the income derived from the revaluations each year still forms part of the company’s taxable profit.

In the 2017 accounts — which still haven’t been signed off by the auditor — Harvey Norman reported a taxable net profit $639.81 million, based on revenue of $1.8 billion. That figure included $107.38 million boost from the property revaluation.

It was a stronger result than the net profit of $493.76 million in the 2016 financial year, which included a $47.79 million boost from the property portfolio.

Harvey Norman founder Gerry Harvey believes his company is well positioned to perform despite a challenging retail environment which is already intensely competitive and under pressure from years of slowing household income growth — even before Amazon starts rolling out its offering in the domestic market, expected in the coming months.

“I think a lot of this is about perceptions — perceptions about the housing market, wage inflation, Amazon, all of these things,” Harvey said after the company’s share price fell 7 per cent on the day its results were announced last month.

“People are looking for ­reasons why you might fail. But if they look at the long-term Harvey Norman story, it is one of the greatest retail ­stories in Australian history.”

This chart shows how the company’s revaluation changes have trended since 2013:

Harvey Norman, Business Insider

The company’s financial statements explain to some degree how the property valuation process work.

Every six months, Harvey Norman has one sixth of its property portfolio independently valued. It’s not disclosed who the independent valuer is. We asked Harvey Norman for comment on this, but a company spokesperson said that the information was not publicly available and referred us back to the annual accounts.

So on a rolling basis over the course of three years, the entirety of the portfolio is revalued externally.

And then the company’s directors review the results of the independent valuation, and form a view on the fair value of the rest of the portfolio.

Here’s an excerpt from Harvey Norman’s (unaudited) 2017 financial statements explaining it:

The investment property portfolio in Australia and properties held in joint venture entities are subject to a semi-annual review to fair market value. At each reporting period, one-sixth of the investment property portfolio is independently valued with the remaining five-sixths reviewed for fair value by Directors. The entire portfolio is independently valued every three years.

The table below summarises our trend analysis of how the company has accounted for its property revaluations over the last five years:

Harvey Norman, Business Insider

Harvey Norman’s latest financials show that during the 2017 financial year, 50 properties in the Australian portfolio were valued externally, “representing 40.0% of the total number of sites”.

That indicates that as at 30 June 2017, the company had 125 properties in its Australian portfolio.

Based on 50 independent valuations, the company directors then applied their own fair-value judgment on an additional 29 properties — 12 more than any other year in the sample.

The yearly financials show that Harvey Norman applies a weighted average capitalisation rate (WACR) in its property value recalculations.

A WACR calculates the expected annual rate of return on a given property, factoring in the interest rate payable on any debt used to fund the purchase.

The 2014/15 financial years didn’t show a specific capitalisation rate, but in recent years where the rate has been declared, the company has said it applied a growth rate on its property portfolio of around 8%.

And this looks reasonable, when you consider the general strength of the Australian property market over the past decade in an era of falling and very low interest rates. Just this week, official ABS data showed nationwide residential property price growth of just over 10% for the year to June.

Property prices have been particularly strong in Sydney and Melbourne. However, the performance of course is not uniform across geographical areas. Western Australia, most glaringly, has seen falls in property prices over recent years. Based on the information in the accounts, it’s impossible to tell where exactly all of Harvey Norman’s properties actually are.

Then again, they are likely to be in largely in the most populous part of the country — NSW and Victoria.

And the company’s property portfolio hasn’t always been a big boost to performance. Back in 2013, Harvey Norman incurred a $60 million loss as the value of its properties was written down.

Here’s Harvey Norman on the loss that year:

The decrements in Australia were generally the result of development losses and a revaluation of a property which was affected by flooding. The values of established properties within the portfolio have remained relatively stable. Recently constructed developments in Springvale, Maroochydore, Emerald and Devonport have generated the majority of the decrement. We believe that these properties are high-quality retail developments that will contribute to increases in operating income in the future as the properties mature.

Over the last two financial years though, the value of the company’s properties — booked as revenue through the company’s statement of comprehensive income — has risen significantly.

That increase looks to have coincided with the purchase of a further seven properties in Australia, which increased the total number of properties by around 6%.

This chart shows Harvey Norman’s share price over the last 12 months:

Investing.com

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.