After being developed in Kyoto in the early 80s as a next generation version of bottomless coffee shops (ノーパン喫茶, nopan kissa), the so called “Fashion Health” industry was and still is a key aspect of the neon alleys in Japan’s red light districts. Fashion Health was a product of the bubble and began to proliferate in 1981.  Nowadays, the government has tightened the regulations (風営法, fu’eiho) considerably and it’s now practically impossible to open a brand new Fashion Health shop. However, due to one of those wacky loopholes that you often find in Japanese law, Fashion Health establishments that were already in operation before the enactment of the new regulation are allowed to remain in business. This government sponsored scarcity has meant that even today as the rest of Japan Inc. are struggling to keep their heads above water, this business is booming. Booming so much that boutique M&A shops have been shifting their focus to the uncharted waters of this industry in order to cover their fixed cost bases in the choppy environment that the sub-prime debacle has created.

But why the sudden boom now? Besides the substantial slow down in M&A in the rest of the market, it seems that demographics are the real catalyst for this boom. The shop owners in this industry are no exception to the aging of society that is troubling the Japan of the 21st century. As their owners slowly reach 70 years old, even owners of “Fashion Health” look forward to their own happy endings and think about retirement. I have a funny feeling that the shacho (社長, president) of such companies have a few more day to day “issues” to deal with in addition to keeping the accounts balanced and would enjoy the peace after retirement more than most. I really can’t imagine how an elderly man would keep his own against a dispute with his friendly neighborhood Yakuza.

Quite recently the owner of “A”, one of Kabukicho’s most famous fashion health establishments is said to have rode this wave of M&A and sold his business to a more energetic young entrepreneur. According to our sources, the greatest number of similar transactions have been in Shinjuku and Yokohama although due to the nature of the business, it is hard to get hard figures.

The beauty of the concept is simple. Unlike call girl services, the customer doesn’t have to pay for a hotel room. What you save him in hotel dollars, he can spend with you… being more of a frequent flier. Although as the shop operator you have to provide rooms, at an average take of about 8000 yen for 40 minutes, you hardly have to worry about capacity issues. Popular stores are said to turn over there rooms about 5 times a day. Even when you factor in that the shop splits the take 50:50 with the “companion” that still makes for 20,000 yen per room per day. It doesn’t take a nuclear physicist to work out that with a tiny 10 room building you are talking 200,000 yen a day or about 70 million yen a year. If you are willing to compromise on quality (and safety standards) then it’s unlikely that a building that size is going to cost you more than 150~200 million yen even in Tokyo/Yokohama. Needless to say this is a gross yield and so you have to subtract a bunch of other costs first but your ROI will still be quite respectable.  For the owners, it’s not a bad deal either – they’re willing to shift into a slower gear and they get a bit of a golden parachute to thank them for the efforts in building the business.

The transaction must be structured carefully. Because the law states that the license for fashion health can only be continued for one generation, this loop hole only exists for owners who were smart enough to own their business and apply for their license through a corporate entity. That way, after any sale, the owner and operator of the business remains the same and it is only the shareholders of the business change (this is a trick that is often used in many countries to avoid real-estate transaction fees and taxes). All the new “owner” then has to do is change the management of his company and he has control of his newly purchased entity. Sounds a helluva lot easier than M&A for normal Japanese companies!

Unfortunately, there is a bit of competition out there. The main buyers so far have been owners of large-scale “health” shops in Susukino and Akebonocho who aren’t afraid of throwing their money where their pants are.  It’s also an attractive option for entrepreneurs in other sub-sectors of the industry, hoping to spread some of their risk.  The most recent transaction that I’ve heard about is for the lease hold of a small shop in Akebonocho (曙町), Yokohama with only 5 rooms that apparently changed hands for 30 million JPY. In that neck of the woods your going to struggle to get 500% occupancy like our previous example (damn that would mean a gross yield on investment of 100%!!!) but you’re still going to get your cash back in a very short time.  Part of me feels sorry for the shacho getting screwed out of the business he built his life on for such a low price, and the other part of me recalls the havoc that unexpected law changes have done to the consumer finance industry recently and I think that perhaps he’s just lucky to get anything for it.

What do you think? Are you interested?  I remember when love hotels were all the rage about 10 years ago.  A bunch of foreign investors came into the market and bought enough love hotels to make a private REIT style investment fund.  Annual yeilds were supposed to be north of 25%.   If anyone ever hears of an opportunity to invest in a Fashion Health REIT, please drop us a line!