Dubai's Sand Castles

As the manager of a Dubai real estate brokerage, Imran Mohamed, a Scot of Pakistani descent, had a front-row seat at one of the most incredible property bubbles ever. Early last year, a few months before the height of the emirate's boom, he fought his way through the lines at the opening sale of a new waterfront condominium development. Such launches always attracted crowds of investors eager to get the first shot at a new offering, but the buzz that day was especially intense, remembers Mohamed. (He asks that his real name not be used because his company is in financial difficulty and he may leave the country.) Helicopters circled the event "as if David Beckham had arrived at the airport," he says. Inside, Mohamed put a down payment on an apartment, walked out the door, and sold the unit to a Russian man on the street for double his purchase price. The man paid cash. In just 20 minutes Mohamed had made $408,000. The lesson: "In Dubai, you can throw your ethics and economics textbooks right out the window, because the rules just don't apply."

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For a long time, the normal laws of economics did not seem to apply in Dubai, the most populous of the seven states that comprise the United Arab Emirates. Abu Dhabi, the seat of political power in the UAE, controls most of the country's oil resources. With less oil to tap, Dubai has used low taxes, easy money and cheap Asian labor to transform itself into one of the region's most dynamic economies. The city state developed a kind of signature swagger, expressed most gaudily in the gargantuan real estate projects — an indoor ski slope, man-made islands shaped like palm fronds, the world's tallest building — that have turned a sandy sliver on the Gulf into one of the world's fastest-growing cities. (See 10 things to do in Dubai.)

Inevitably, though, the laws of economics have reasserted themselves. Since oil prices plummeted, and world stock markets crashed last fall, some $75 billion worth of real estate projects have been suspended and canceled in Dubai, according to a report by the local branch of HSBC bank. Business journal the Middle East Economic Digest puts the figure at more than $300 billion. Postponed developments include the World, a luxury man-made island community designed to resemble a world map, and Dubailand, a theme park planned to be twice the size of Florida's Disney World. Housing prices have fallen 20%-40% from their peak in late 2008, and about 30% of the city's existing real estate space is lying empty.

The gloomiest predictions — that the sand dunes will reclaim the skyscrapers — are overdone. Abu Dhabi has kept Dubai afloat by snapping up $10 billion of a $20 billion Dubai bond issue. Among other things, the bailout money has helped shore up the state-owned development companies behind most of those massive building projects. Still, the shakeout is probably not over yet, according to Saud Masoud, an analyst at the Dubai office of investment bank UBS. Masoud predicts house prices could eventually fall as much as 70% from last year's highs. "You can't just put in more capital," he says, arguing that Dubai needs to be more transparent about the seriousness of the real estate crisis, and diversify its economy. "At some point demand has to meet supply. Dubai needs to think long and hard about rebranding itself into something more than just a luxury real estate investment paradise. Right now investors are scared."

Dubai's rise had been decades in the making, but the property market really exploded following a 2003 law change that made it easier for foreigners to own land. With credit cheap and readily available, no income tax, and many more sunshine hours than Britain or Russia, Dubai attracted a new wave of Europeans, who arrived with big hopes and little understanding of Muslim values. In one infamous culture clash, two Britons were imprisoned for having sex on a public beach and insulting police officers after a drunken Friday brunch.

See pictures of Dubai.

See pictures of migrant workers in the Gulf.