TOKYO, May 26 (Reuters) - They wake up, grab their binoculars and head for a shady spot to watch people unobserved. Settling in, they count the number of couples visiting one of Japan's ubiquitous "love hotels" for secret assignations and afternoon trysts. For due diligence contractors hired by offshore private equity firm MHS Capital Partners, it's just another day at work.
TFour years ago, Miro Mijatovic had an idea: harness the cash flows enjoyed by Japan's love hotels that sell rooms in short blocks of time by securitising them for the debt market.
In a first of its kind, Mijatovic and partners Scott Delany and Hamish Ross set up a $10 million pilot fund that has attracted 12 European, U.S. and Asian investors, including two unnamed institutions.
MHS plans to invest in up to four love hotel properties worth up to $4 million each, paving the way for a bigger $100 million fund and targeting net returns of at least 20 percent.
One stumbling block is the industry's seedy reputation.
Major international and domestic investment firms have yet to make any similar investments in Japan, wary of getting into bed with an industry often tied to Japan's "yakuza" gangsters, who some analysts estimate are connected to 20 percent of the hotels.
"When you invest in real estate for a long period of time, there is a very good chance you will come into contact with the yakuza at some point," said an attorney at an international law firm. "Few international institutions are willing to deal with that kind of reputational risk."
Concerned about getting into unwanted entanglements themselves, MHS, which has yet to acquire a property, has drawn up a stringent set of investment criteria including a focus on hotels on the periphery of Tokyo to avoid red-light districts.
But Mijatovic, a Croatian-born Australian and a 14-year veteran of Japan, sees the hotels as a sound financial investment as long as the due diligence process combs out any connections to organised crime.
"It's a legal business, it makes good money, and it's a serious part of the Japanese economy," Mijatovic said.
ANIMAL DESIRE
MHS has reason to be optimistic. While a 70 percent occupancy rate for an average hotel is considered respectable, the average occupancy rate for a love hotel is 260 percent.
And although many companies' fortunes wax or wane with the rise and fall of the economy, love hotels -- like other sex-related businesses -- have proven durable to economic cycles.
"Customers decide to go or not mainly based on animal desire," said Takashi Kadokura, an economist at Dai-ichi Life Research Institute.
He estimates the love hotel industry rakes in at least four trillion yen ($36 billion) a year -- nearly four times the operating profit of Toyota Motor Corp (Tokyo:7203.T - News), Asia's most valuable firm, for the year ending last March.
Investors have also shown they have an appetite for sex.
They jumped on the initial public offering of Australian bordello enterprise The Daily Planet (Australia:DPL.AX - News) last year, helping the world's first publicly traded brothel raise $2.3 million in its market debut.
Most of the customers using Japan's 17,000 love hotels are between 20-27 years old, many of whom continue to live with their parents because of high rents.
Others live with extended family in homes with paper-thin walls and use love hotels to snatch a few moments of privacy.
And unlike the motels frequented by frisky couples in the United States, those seeking sexual healing in Japan can choose from a range of properties designed specifically to lure people from their bedrooms.
Almost all rooms are fitted with karaoke machines and televisions. Some have chandeliers.
Kato Pleasure Group, which made 12 billion yen in revenues last year and is one of Japan's top love hotel operators, runs 42 properties with themes ranging from Cinderella to "Christmas every day".
"It's not just about sex," said Kato Pleasure Group head Tomoyasu Kato, adding he plans to expand his love hotel empire to 100 by 2010. "It's about the entire experience."
QUICK TURNAROUND
While the cost of a double room at a major hotel in Japan can run up to 30,000 yen ($268) a night, randy couples pay around 3,000-4,000 yen for a "rest" of two hours and at least 8,000 yen for an overnight stay at a love hotel, which has been around in one form or another since the 17th century.
MHS says the average stay for a couple is 45 minutes, allowing for quick turnaround with a highly efficient cleaning staff who spend on average 15 minutes a room armed with unorthodox cleaning instruments such as long-handled steel tongs.
"The trick is getting that room back on the market as soon as possible," said Mijatovic.
The only major investment is the bathroom, which takes up most of the 4-5 million yen spent on renovating each room -- an expensive necessity spurred by the tastes of the industry's target audience: Japanese women.
"If the woman doesn't like the place, you're not going to get repeat business," said Mijatovic.
Investing a considerable amount of their own net wealth, the MHS partners believe they are onto something big.
"Savings. And faith," said Managing Director Delany, when asked what he is living on until the fund turns a profit. ($1=111.84 yen)