Reliance Communications (RCom) recently announced that it plans to hive off its real estate assets into a new firm, Reliance Properties.

But the telecom firm’s property venture may take a while to pay off, based on our analysis.

For one, the valuation of Rs 12,000 crore, estimated by RCom, is based on current market prices, which may witness correction by the time the property comes to the market.

Already, there are downward pressures on the office-space market due to the global slowdown and reduced demand.

About 7 million sq ft of office space was absorbed in the March-June 2013 period , a decline of 6 per cent over the previous year, according to real estate research firm CBRE.

Two, even if land is available, the real estate business is quite capital intensive. Interest rates are high and most property developers such as DLF and Unitech are already struggling with high debt and interest service costs.

“Property prices in Mumbai and Delhi have risen and there are currently downward price pressures,” points out Pankaj Kapoor, Head of real estate consultancy firm Liases Foras.

Listed Mumbai developers such as Oberoi Realty are facing growth issues due to the challenging local market, which has been saddled with increasing supply and reducing demand.

In such a scenario, it will not be easy for RCom to monetise its real estate at very profitable margins.

The Gameplan

According to RCom’s plan, Reliance Properties will take over the company’s property assets and develop them to unlock value.

RCom shareholders will receive one share of Reliance Properties for every share they now hold in the company.

RCom has estimated that the value of the new firm is Rs 60 a share. But the market seemed sceptical as the price of RCom’s share only increased from Rs 136 to Rs 145, after the announcement. So, how much does the company stand to gain from its property venture?

For RCom, the motivation for setting up the property arm seems to be that it will offer much higher realisations than a plain sale of land. RCom owns 135 acres of land in Navi Mumbai (Dhirubhai Ambani Knowledge City), with an estimated saleable area of over 15 million sq ft.

It also owns four acres of property in Delhi near Connaught Place. Retail space in Navi Mumbai was valued at Rs 7,000- 12,000 a sq ft in May, estimates Jones Lang LaSalle. Based on this estimate, the potential value of RCom’s property after development would be around Rs 12,000 crore.

Office properties in Connaught Place, New Delhi were quoted at Rs 28,000- 35,000 a sq ft. Assuming RCom develops offices on its Delhi property, the developed value would stand at Rs 1,400 crore. These estimates seem to be in line with RCom’s claim. The company’s press release said that the “preliminary and indicative monetisable value of RCom’s real estate on development is estimated by independent valuers at over Rs 12,000 crore ($ 2 billion)”. This would place the value of developed land at about Rs 60 per current RCom share.

Shareholder value

RCom, on its part, has indicated that it will work with global partners to ‘unlock the value’ of this asset.

But taking the partnership route may reduce RCom’s share of the property, thereby reducing its share of the estimated gains too. Property development also involves a long lead time due to delays in gaining approval and sanctions.

So the money, even if fully realisable, may take time to flow in.

Assuming the land price is 20 per cent of the sale price, RCom would have earned around Rs 2,700 crore from direct sale of these properties.

This works out to around Rs 13.5 a share of RCom.

Based on the share price appreciation of around Rs 10 per share, the market may be factoring in just the land value. It is not willing to bet on the venture paying off as yet.

In the last couple of years, many companies with debt issues have sold or developed parcels of prime real estate to unlock cash.

Some have created separate real estate arms so that the main company can focus on the core business and not be distracted by property management.

“Today, corporate real estate holdings in India have emerged as a dynamic asset class, to warrant a strategy for these assets,” says Ambar Maheshwari, Managing Director, Corporate Finance, Jones Lang LaSalle India.

Development route

Direct sales may be the only choice for companies that are urgently in need of cash.

For instance, DLF, despite being a developer, sold around 17 acres of land in Mumbai for Rs 2,700 crore in 2012. This may also be the preferred way if the value that can be unlocked from development is not attractive compared to the immediate pay-off.

However, in some cases, the landowner may not be able to find buyers willing to pay a high price.

Compared to direct sale, those who have the luxury to hold on to and develop property can see substantially higher sale proceeds.

“Those who can afford to wait for a few years may earn higher returns through land joint development” says Anshuman Magazine, chief executive of CBRE’s Indian operations.

For instance, Phoenix Mills started property development on its textile mill land in the early 1990s.

The company has expanded in many cities and now its textile business exists only in name.

Large corporate houses such as Mahindra and Godrej, owners of large tracts of prime real estate, have also floated real estate arms that have turned out quite profitable. It is this route that RCom seems to be taking.

However, not all such ventures succeed, points out Sanjay Dutt, Executive Managing Director, South Asia, for Cushman and Wakefield India.

Consumer electronics maker Videocon and software developer Satyam’s foray into the realty sector was not very successful.

In 2008, cigarette maker GTC de-merged its 14-acre land in Mumbai and other property assets for joint development. The deal, inked in 2010 and worth over Rs 500 crore, is still caught up in a legal tangle.

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