Abu Dhabi (cont.)

By Barney Gimbel, Fortune writer

As his country became wealthy, Zayed insisted that "not a single grain of sand" be sold. Though most men received plots of land, transferring ownership required the sheikh's approval. As a result, native-born Arabs - rapidly becoming a minority in their own country - got land while outsiders couldn't buy any. That made it difficult to attract foreign investment, especially when oil prices plunged to $18 a barrel in the late 1990s.

The government's most ambitious plan at the time, the Saadiyat Free Zone Authority, an attempt to create a free-market financial and commodities center on a sandy island, never made it past the planning stage. The same fate met a proposal to build a theme park and resort on a man-made breakwater known as Al Lulu Island. One reason: Foreigners couldn't own any land.

Dubai learned that lesson early. The emirate legalized property sales to locals in 1997 and five years later, in certain areas, to foreigners too. Wealthy Middle Easterners - including those in Abu Dhabi - accustomed to buying Italian villas and U.S. T-bills suddenly had viable investment opportunities close to home. Cash poured in, and hotels, condos, and malls sprang up. Soon Dubai was the place where Saudis shopped, Brits tanned, and Russians partied.

As Dubai raced ahead, Abu Dhabi stood still - a Melbourne to a Sydney, a Philadelphia to a New York. One businessman remembers weeds growing out of cracked streets in 2000. Zayed had grown ill, and no one dared to suggest radical changes. Another problem: Zayed technically owned all the land. "The horses were being held behind," says al Bowardi.

That all began to change in 2004, after Zayed's death. Power fell to two of his 19 sons: Sheikh Khalifa, his eldest, became President, and the much younger Sheikh Mohammed became crown prince, taking over the day-to-day running of Abu Dhabi. Soft-spoken but shrewd, Mohammed is considered the most Western of the emirate's leaders. A graduate of Britain's prestigious Sandhurst military academy, he used his control of the UAE's armed forces to amass the economic and political clout he needed to become the heir apparent to Khalifa. (He's also a pretty good fighter pilot.)

One of the first projects to get off the ground was Abu Dhabi's own international carrier, Etihad Airways. The idea was to duplicate the success of Emirates, the airline that helped put Dubai on the map as a tourist destination with its high-class service. So Etihad placed an $8 billion order with Airbus, including four A380s. "It's a function of geography," says James Hogan, Etihad's Australian CEO. "We're in the middle of the world and can act as an air bridge between Europe, Asia, and the U.S."

Three years later it's difficult to assess Etihad's success, since it doesn't report earnings, but analysts doubt that two long-haul carriers can profit in such close proximity. "The idea that just anyone can put a stick in the ground and watch it grow into a tree is ludicrous," says Richard Aboulafia, an aviation analyst at Teal Group. "There really isn't enough traffic, not to mention that the European and Asian carriers are starting to fight back." But if the airline's goal is to put Abu Dhabi on the map, it's starting to succeed - it carried three million passengers last year, more than twice the number in 2005.

The next thing Abu Dhabi needed was a landmark. The answer was the $3 billion Emirates Palace hotel, with its $1,000-a-night rooms and $10,000 suites. It was Abu Dhabi's bid to outdo Dubai's Burj Al Arab, the $1 billion sail-shaped hotel that has become a tourist attraction. The plan worked: While the Emirates Palace doesn't seem to have many guests, it does have gawking European tourists.

But the most important change was Law No. 19. It formally abandoned the old property regime and permitted the sale of land by citizens and, in some areas, the purchase of 99-year leaseholds by foreigners. The real estate boom started immediately.

"Many people here had been investing heavily in Dubai," says Ahmed Ali al Sayegh, who founded Abu Dhabi's first private-property development company, Aldar Properties. "This was the first time they could do something in their own city." When he took Aldar public in 2005, it was oversubscribed more than 450 times. People waited in line overnight to buy villas in Al Raha Gardens, Aldar's first project. The $400,000 units sold out in 45 minutes.

But as much as Aldar was modeled after Emaar Properties, the development company that built much of Dubai, there wasn't a rush to simply copy what Dubai did. After all, beneath that city's glitter are serious problems no one likes to talk about. Its infrastructure is overtaxed, inflation is climbing, and crime and prostitution are on the rise. Abu Dhabi has a more traditional and more religious population, unwilling to sacrifice its way of life for tourist dollars.

That's why it is building the world's second-largest mosque. That's why the Emirates Palace looks right out of The Arabian Nights. That's why the city's planned Central Market has a souk. It's even evident in the advertising. In Dubai, property ads feature pictures of smiling, wine-drinking Westerners frolicking on the beaches. In Abu Dhabi they tend to show Arab families in traditional dress. "We don't seek to become a commoditized destination for mass tourism," says Sheikh Sultan bin Tahnoon al Nahyan, chairman of the new Abu Dhabi Tourism Authority. "We're creating an exclusive, high-end tourist destination."

Perhaps the best example of that is Saadiyat Island, a $30 billion project that includes 29 hotels, three marinas, two golf courses, and housing for 150,000 people. But what makes it different from Dubai is the attempt to create a cultural oasis in the desert. "When we were designing it, we thought there had to be some of what we call 'pearls,'" says Jose Sirera, an architect with Gensler, a San Francisco firm that designed the master plan for the island. "It needed art galleries or museums or special gathering places."

Soon the crown prince was meeting with Thomas Krens, the director of the Guggenheim Museum in New York City. "He said he wanted a cultural destination that everybody in the sophisticated world of art and culture would have to visit," Krens says. "So I said, 'Let's take what's worked around the world and magnify it by 50%.'"

The result: a 670-acre cultural district designed by some of the world's best-known architects, including Zaha Hadid, Jean Nouvel, Tadao Ando, and - at the special request of the crown prince - Frank Gehry, who will try to outdo what he did for the Guggenheim in Bilbao, Spain. For good measure, Abu Dhabi offered a reported $1 billion for an outpost of the Louvre, the Paris museum's first. The entire plan is estimated to cost billions. "I never expected to be able to design another one of these places," Gehry says. "But in Abu Dhabi you can do things that would be unthinkable anywhere else."

All that highbrow intention doesn't mean Abu Dhabi hasn't borrowed some Dubai-like ideas. Yas Island will have a Ferrari theme park and driving school (Abu Dhabi owns 5% of Ferrari through Mubadala), a racetrack winding its way around the island, water parks, a dozen hotels, four polo fields, a golf course, and a Formula One racing team. The Danet Abu Dhabi development will feature 36 mixed-use towers, two shopping malls, two mosques, and a five-star hotel. On Al Reem Island, Shams Abu Dhabi will have a canal system like Venice's, a central park like New York City's, and an 83-story skyscraper.

So if they build it, will they come? Certainly some of the residential projects will sell, because Abu Dhabi faces a housing shortage and rents that are increasing almost 50% a year. (A three-bedroom apartment is as expensive as in Manhattan.) Other projects may never get off the ground. But Davidson, the UAE expert, thinks Abu Dhabi has a better model than Dubai's. "Dubai relies totally on commerce and tourism, so if there were a war, instability, or terrorism, Dubai is finished," he says. "Abu Dhabi's brand of tourism would be able to bounce back. It's not relying on Europeans who could change their favorite destination on a whim. Abu Dhabi is going after Arab tourism and investment."

Still, Abu Dhabi faces some of the same property-bubble dangers as its neighbor to the north. While much of Dubai has been purchased by real estate flippers, the city has become a legitimate business capital, with thousands of expatriates moving in each month. It's going to be difficult for Abu Dhabi to attract the kinds and quantities of multinational companies that have set up shop or opened regional headquarters in Dubai.

The folks in Abu Dhabi don't seem to worry about such things. After all, they say, they are not just diversifying into real estate and tourism. Mubadala is involved in development projects around the world, including oil exploration in Libya and telecom systems in Nigeria. The Abu Dhabi Investment Authority, which Sheikh Zayed set up to manage the emirate's oil profits in 1976, now has an estimated $1 trillion invested in world markets.

That's why Abu Dhabi matters, says Tom Pritzker, chairman of the Global Hyatt hotel company, who is considering several deals in the emirate. "Tomorrow's world may see the U.S. as the center of innovation and military strength, China as a center of population and economic growth, and the Middle East as a primary source of oil and capital," he says. "These guys are very important to our growth and stability, because at their core they are simpatico to our values and approach to life. They are smart, sophisticated, and well trained - they could just as well be working at Goldman Sachs or Blackstone."

Khaldoon likes to tell a story about how the crown prince works. Abu Dhabi's outdated seaport, situated in a prime location, was causing problems for redevelopment. "He said, 'We've got to find a new location,'" Khaldoon says. "Within 60 days, everyone came back. All the options were put on the table. He made his decision right there. Boom. A new location for a new port and the land to go with it. Things like that just don't happen this quickly anywhere else in the world."

Then again, there's Dubai.

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