If you've looked at a medical office or retail deal, you've probably seen "NNN" in the summary.

It stands for triple net. It's one of the simplest ideas in commercial real estate, and one of the most misunderstood.

The short version

In a triple net lease, the tenant pays the rent plus the three big costs of owning the building:

1. Property taxes

2. Building insurance

3. Maintenance and repairs

The landlord collects rent, and the tenant covers most of what it costs to keep the building running.

Compare that to an apartment, where the owner pays taxes, insurance, repairs, turnover costs, and often some utilities. Those costs go up every year whether rents do or not.

The lease spectrum

Leases sit on a spectrum based on who pays what:

One thing to know: "NNN" isn't a legal standard. Two leases both called triple net can split roof, parking lot, and HVAC replacement differently. Always read who pays for the big-ticket items.

The math

Let's compare the same building under two kinds of leases.

Gross lease: The tenant pays $125,000 a year. You pay $12,000 in taxes, $5,000 in insurance, and $8,000 in maintenance.

• Your net income: $125,000 minus $25,000 = $100,000

Triple net lease: The tenant pays $100,000 in rent and covers the $25,000 of expenses directly.

• Your net income: $100,000

Same income in year one. So what's the difference?

Say property taxes jump 30% after a reassessment, and insurance goes up 20%. Under the gross lease, that comes out of your pocket. Under the triple net lease, it's the tenant's problem.

Over a 10-year lease, that difference adds up. Your income is much more predictable.

How NNN income turns into building value

Commercial buildings are valued on their net operating income (NOI). The formula is:

Value = NOI ÷ cap rate

The cap rate is the yield a buyer is willing to accept. A lower cap rate means a higher price.

Using our $100,000 of NOI:

• At an 8.0% cap rate: $100,000 ÷ 0.080 = $1,250,000

• At a 6.8% cap rate: $100,000 ÷ 0.068 = $1,470,588

Same building, same rent, about $220,000 difference in value. That's why buying at a higher cap rate than the market pays is so important. More on that in How to Read a Real Estate Investment Summary.

What the landlord still carries

Triple net doesn't mean zero risk. The landlord still owns these problems:

• Vacancy. If the tenant leaves, you pay all the expenses yourself and get no rent until you find a replacement.

• Tenant credit. The lease is only as good as the tenant's ability to pay.

• Roof and structure. In a standard NNN lease, these are usually still yours. Only an absolute net lease shifts them fully to the tenant.

• Slow rent growth. Many NNN leases have fixed bumps of 0% to 3% a year. If inflation runs hotter, your rent falls behind.

What to look for in an NNN lease

These are the first things worth checking in any NNN lease:

• Term remaining. How many years are left? A 10-year lease with 2 years left is really a 2-year lease.

• Rent increases. Is there a fixed annual bump, and how much? Is it tied to inflation (CPI)?

• Guarantee. Who backs the lease? A single doctor, the practice, or a large parent company?

• Rent as a share of tenant revenue. Experienced medical landlords like to see rent under about 10% of the practice's revenue.

• Renewal options. Can the tenant extend, and at what rent?

• Roof, HVAC, and parking lot. Who pays when these wear out?

• Assignment. Can the tenant hand the lease to someone else if they sell the practice?

Sale-leasebacks

You'll often see NNN leases created through a sale-leaseback. A business owns its building, sells it to an investor, and signs a long lease to stay in it.

The business gets cash to grow, and the investor gets a tenant that's already settled in. This is common in medical and dental, where practices are being bought by larger groups that would rather own the business than the building.

The bottom line

A triple net lease moves most of a building's operating costs and headaches to the tenant. That's why NNN real estate tends to produce steady, predictable cash flow.

It isn't hands-off for the owner, though. You're still betting on the tenant, the lease terms, and the price you paid. The lease is only one part of the deal. The tenant behind it matters just as much.

Want to see how this plays out in medical office specifically? Read Medical Office Real Estate Investing: A Plain-English Guide.