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11/30/2009

The traditional laws of business no longer seemed to apply in this Gulf megalopolis. Real estate developments were sold before completion, sometimes several times and sometimes to investors putting less than 10 percent down, generating double-digit returns for speculators engaged in the insane practice of "flipping." About a quarter of Dubai's gross domestic product was generated in the construction and real estate sector, and for a time one in four of the world's construction cranes was being operated in Dubai.

The bubble was fed with money from around the world. To turn its fantastic visions into reality, the emirate borrowed a massive amount of money -- about $80 billion -- on international capital markets in recent years. About $50 billion of that debt will mature by 2013.

It will now be difficult, if not impossible, to repay such vast sums of money. All of the calculations that were once made no longer add up.

Collapsing Prices

Real estate prices have collapsed and are now only half of what they were a year ago. And yet new villas and luxury condominiums are still being completed every day -- and are standing empty. Entire floors are deserted in the skyscrapers along Sheikh Zayed Road, and giant banners with the words "To Let" are displayed across the fronts of buildings. Real estate experts estimate that only 41 percent of office space is occupied, and the vacancy rate is only expected to increase. In 2011, Dubai, a city of about 1.5 million, will have more office space available than Shanghai, which is 10 times as large as Dubai.

Domestic banks financed part of this megalomaniacal building boom, partly because they had no choice. No one dared to question the creditworthiness of state-owned companies when they applied for loans. The banks, says one insider, deteriorated into an "extended arm" of the government, "and now the whole thing is running aground."

Little of this had become public knowledge, and until Wednesday the mood within the emirate was still confident. Dubai seemed to have weathered the financial crisis well. Only recently, the airport was still reporting a rise in passenger volume, while more goods were imported through the Jebel Ali container port in the last three months than ever before.

No More Bailouts?

Most of all, however, oil prices have been rising again for months, which until now has indirectly benefited the emirate, whose own wells are drying up. Higher oil prices meant a secure influx of income for the neighboring emirate of Abu Dhabi, which has about 7 percent of global oil reserves. People in Dubai expected wealthy Abu Dhabi to help them out again, if necessary.

At the beginning of the year, Abu Dhabi had already saved Dubai from bankruptcy with a $20 billion bailout package. But even sums of that magnitude were apparently not enough to service the emirate's loans, and the money disappeared like oil from a leaky barrel.

"One could almost assume that Abu Dhabi had cancelled, or at least reduced, Dubai's line of credit," says Bernhard Solleder, who has been working as an investment banker in Dubai for the past three years. He suspects this is the reason why the emir suddenly had to pull the emergency brake on Dubai. According to Solleder, the wealthy sheikhs are simply tired of constantly having to take responsibility for Dubai.

Other bankers believe that last week's surprise annoucement was a bold attempt by Dubai to threaten its wealthy neighbor. In recent months, Abu Dhabi had apparently tied its commitments to ever more stringent conditions. According to sources in the emirate's banking community, Dubai -- completely overestimating its power -- may have been trying to put the sheikhs in Abu Dhabi under pressure with the announcement by insisting, in effect, "if you don't help us, we'll both go down together." However the attempt to influence Abu Dhabi -- if that is what it was -- failed miserably.

But the money for Dubai's ludicrous development projects didn't only come from its rich neighbor, but also from thousands of small investors from around the world, including Germany. Now they are all stuck in the same trap. Real estate investment funds can't get rid of their properties, and some have put a stop to planned payouts.

"Our phones have been ringing off the hook since Wednesday afternoon," says Josef Kleindienst, an Austrian real estate developer. The calls have been from extremely nervous investors, mainly from Germany, he says. "Many simply want to get out," says Kleindienst. "I can understand them very well. Capital is like a shy deer, and suddenly loud gunshots are going off here."

Desert Boom

For years, investors believed in the vision of a booming metropolis in the desert. Financial institutions promised outrageous returns on investment, which were even tax-free until recently. But the first doubts were raised early on. Even the member firms of the German association of closed funds, not exactly known for their squeamishness, were unwilling to include Dubai products in their range. They were too concerned about the legal basis for real estate transactions, which could usually only be carried out via local agents.

Other providers, however, remained undaunted. Since 2004, Alternative Capital Invest (ACI), a company based in the northwestern German city of Gütersloh, has attracted roughly 8,000 investors, and about €250 million, to various Dubai funds. Only about a year ago, ACI was still boasting: "Investors in the V. Dubai Tower KG are receiving maximum dividends." ACI retained retired celebrity athletes like tennis star Boris Becker and former racing drivers Niki Lauda and Michael Schumacher to endorse their products. "All I did was allow them to use my name, and I got less than €1 million in return," Lauda admits today.

There were plans to develop a "Boris Becker Business Tower" and a "Michael Schumacher Business Avenue" in Dubai, but neither of the projects has been completed or is even on the drawing board. According to property records, the Nakheel Group is responsible for part of the projects.

ACI's investors have now begun to fight back. They have formed an association and they plan to take the case to court. ACI refuses to disclose when dividends will be paid, saying only: "It depends entirely on developments in the global economy in general and on Dubai's future economic situation in particular."

End of an Era

As of last Wednesday, that situation is more than uncertain. Sheikh Mohammed is playing for time. It was hardly a coincidence that he released his bombshell about Dubai's financial problems shortly before the holidays, because offices and many shops in the emirate are closed until the end of the week. This gives him a few days' worth of breathing room. But on this Wednesday, a national holiday in the United Arab Emirates, it will finally become clear to everyone in Dubai than the golden years are over.

The opening ceremony for the 818-meter Burj Dubai, the world's tallest building, was originally scheduled for Wednesday. But now it has been delayed.

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• Part 1: Dubai's Debt Woes Unsettle Financial World
• Part 2: The Dubai Dream Runs Aground