OK I think I got things to work much better. I had installed rails using
apt-get (which happen to get me version 1.2.1). Uninstalled that and
reinstalled it using gem instead (now getting version 1.2.3). Updated
the paths in Window -> Preferences... -> Rails -> Configuration to point
to /var/lib/gems/1.8/bin/... And now, everything seems to be working
much better. In summary:

sudo apt-get remove rails rake
sudo apt-get install ruby irb ri rdoc ruby1.8-dev build-essential
sudo gem install rails --include-dependencies
sudo gem install mongrel

In Window -> Preferences... -> Rails -> Configuration:
Rails path: /var/lib/gems/1.8/bin/rails
Rake path: /var/lib/gems/1.8/bin/rake
Mongrel path: /var/lib/gems/1.8/bin/mongrel_rails

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RadRails fails to create new rails projects in Eclipse
https://bugs.launchpad.net/bugs/102905
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