Dubai: Is the Worst Over?

On the surface, Dubai doesn't seem as hard hit by the global recession as one might think. At 11 o'clock on a recent evening, the emirate's gigantic airport was crowded with travelers facing 15-minute waits at passport controls. Restaurants and nightclubs are filled with a cosmopolitan mix of visitors and locals.

And Dubai hasn't completely lost its old pizzazz. On a recent evening, Mohamed Alabbar, the tireless chairman of Emaar Properties, the emirate's largest real estate developer, proudly walked with visitors on the newly opened promenade around the spectacular artificial lake that lies at the foot of the nearly completed Burj Dubai, the world's tallest building. As the voice of Andrea Bocelli sang Time to Say Goodbye, colored sprays of water danced high in the air like a fireworks display. Alabbar said the fountains, which are meant to outclass a similar waterworks at Las Vegas' Bellagio hotel and casino, had cost more than $250 million. "If it makes people happy, it's O.K.," he said.

But scratch a little deeper, and there are signs of malaise. Real estate prices are down by as much as 50%, and, because the authorities are pressuring developers to finish projects they have begun, empty space is piling up. According to a recently released survey from London real estate consultancy Knight Frank, over the past year Dubai has suffered by far the steepest drop in residential property prices among 32 developed economies surveyed worldwide, down 47.3% on average. (The second-worst market, Singapore, saw prices fall 27.7% over the same period, from June 30, 2008, to June 30, 2009.)

Staff Cutbacks Dubai's two biggest local real estate developers, Emaar and Nakheel, initially chose not to have stands at the annual Cityscape real estate exhibition that began on Oct. 5 in the emirate, but eventually relented. And with deal flow slowing to a trickle, Western investment banks have cut back on their Dubai personnel, reverting to their former practice of flying in professionals from London.

Dubai will clearly take some time to recover from the hit it has taken. At heart a real estate play, the emirate now needs to contend with a substantial overhang of both residential and commercial property. If there is a bright spot, it's that rents and prices that had become astronomical have come down. Khaled Al-Muhairy, chief executive of fund manager Evolvence Capital, says that while the owners of the towers that have gone up all over Dubai in recent years may be hurting, the companies that rent space in these buildings are getting much better deals—and there are far more of them.

But credit remains tight, and bankers say Dubai is going to have a tough time returning to the markets until it shows a clear strategy for paying off its estimated $85 billion in debt. There is also a lot of worry about a $3.5 billion Islamic bond, or Sukuk, for Nakheel that comes due near the end of the year. (Bankers think it will be rolled over.) Of more concern, they say, is the $50 billion or so that "Dubai Inc." needs to pay back or refinance over the next three years. Regional investment bank EFG-Hermes estimates Dubai's payment schedule at $13.1 billion in 2010, $19.5 billion in 2011, and $15.7 billion in 2012.

Once Dubai's leadership got their hands on the $10 billion loan from Abu Dhabi last summer, they seemed to have become less serious about working out debt and restructuring their companies. The loan was supposed to have been just the first tranche of a $20 billion fund raising, but the source for the remaining $10 billion is unclear; capital markets don't seem to be an option. In the end, the rest is likely to come from Abu Dhabi, the wealthiest emirate in the United Arab Emirates and Dubai's biggest backer. But the two sides are struggling to reach a deal. One theory has it that Abu Dhabi is asking Dubai to put up collateral in the form of stakes in one or more of its crown jewel companies, Dubai Aluminum, Emirates Airline, and harbor operator Dubai Ports World. A possible solution: A loan could be structured like a mortgage, with Dubai regaining its equity if and when it pays off its debts.

A Respite from Congestion Now that markets have improved, some of the foreign investments Dubai made in frothy 2006 and 2007 are beginning to regain value. But businessmen say Dubai's debt situation makes banks reluctant to lend to anyone there.

To be sure, people in Dubai are no slouches when it comes to making lemonade out of lemons. Even with the recent declines, the gleaming city they've created on what was once a patch of windblown sand is quite an achievement. One now hears around town that Dubai will benefit from this enforced breather because its infrastructure had fallen badly behind its ambitions and population growth. A combination of new roads and thinned traffic has reduced congestion, which had become a serious problem. And a new Metro, long a subject of skeptical comment, now offers partial service, with trains running up and down Sheikh Zayed Road in the financial district.

Still, some strains to the infrastructure remain visible. For instance, Dubai's long, narrow harbor—known as the Creek—has recently been the scene of massive fish die-offs. The local press has speculated that the cause is an overloaded sewer plant dumping insufficiently treated sewage in the water.

Publicly, at least, Dubai's leaders still put on a brave face. Alabbar, who is delivering on huge projects such as the Burj but has seen Emaar's U.S. arm file for bankruptcy, said that in hindsight he might have been "more cautious." But he doesn't think Dubai's strategy of being a hub for "1.5 billion people" in the Middle East, Asia, and Africa needs revising. "No one can do what Dubai did," he says. "Even more so now."

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