Dubai or Not Dubai?

In the 1989 movie Field of Dreams, an Iowa corn farmer, played by Kevin Costner, hears voices in his head. The voices encourage him to build a baseball diamond in the middle of a cornfield. Those voices repeatedly tell him, “If you build it, they will come.” Apparently, these same voices were in the heads of the leaders in Dubai, but instead of building a baseball park in the middle of a cornfield, they decided to build tens of billions of dollars worth of condos, offices, malls and even casinos.

Unfortunately, this emirate is one of the few in the region without much oil; therefore, the resources to build their dreams were almost exclusively borrowed. And, more unfortunately, after they built it, very few have come.

Fiscal problems in Dubai dominated the headlines last week as the emerging emirate announced that it needed to halt payments on some of its sovereign debt for six months. Dubai itself demonstrates just how quickly countries can veer off the road to recovery and into trouble. More importantly, for investors across the globe, their debt debacle is stoking new fears that heavily indebted nations could potentially default on their government debt.

No one disputes that many countries gorged on cheap, readily available debt during the boom years, but the clear poster child for this trend was Dubai. Although the city-state is one of the few members of the United Arab Emirates (there are seven member emirates) that has little oil wealth of its own, it does act as the emirates’ trading, tourist and financial hub. It had always been assumed that, in the case of financial stress, the U.A.E.’s richest oil state and capital, Abu Dhabi, would bail out its free-spending neighbor. Abu Dhabi’s initial refusal to assist Dubai was a reminder that policy makers might not be willing or able to solve all of the world’s credit problems with easy money, and has raised fresh worries among investors about sovereign support for Dubai’s debt-laden corporate entities. Alternatively, new credit worries could lead central banks to become even looser with money, encouraging another round of risk-taking.

Dubai World, the corporate face of the emirate, is at the heart of Dubai’s debt woes. It is a conglomerate that, for years, has led the emirates’ high-profile domestic and overseas investment ambitions. Going back to the 1980s, Dubai initiated a building boom to transform an underdeveloped region into a modern landscape of dazzling residential and commercial skyscrapers and beach-side luxury hotels. To implement this strategy, the government turned, in large part, to Dubai World, which turned to international debt markets for the capital to make things happen. Almost 50 percent of Dubai’s $60 billion to $80 billion (depending on which report you read) in debt is related to Dubai World and its entities.

The real estate development arm of Dubai World is Nakheel, most famously known for building the city’s iconic palm-shaped island developments. In 2007, Dubai’s property markets were in full swing, and dredging had actually begun on two additional palm-shaped developments. In early 2008, sales began for the first phase of this massive project, which added 500 miles of new beachfront property to the landscape, with the potential to house 400,000 people. Initially, demand was very strong, and units were being flipped regularly, as monthly appreciation was enormous.

Those of us in New York are probably most familiar with Dubai World’s investment arm, Istithmar, which had purchased several large office properties in Manhattan. Among these were 230 Park Avenue, which they purchased in November of 2005 for $705 million. This property was sold about a year later for $1.15 billion. Istithmar also purchased the Knickerbocker Hotel at Six Times Square, which they intended to convert into a luxury hotel. It also purchased 280 Park Avenue, which it subsequently sold for more than $1.2 billion, and the leasehold on 450 Lexington Avenue, for which they paid about $600 million. Hotel acquisitions other than the Knickerbocker included the W Hotel Union Square and a majority share of the Mandarin Oriental in the Time Warner Center. Istithmar also purchased high-end retailer Barneys New York for nearly $1 billion, well above initial estimates and due to a bidding war in which they prevailed.

Dubai or Not Dubai?