What happened

A bad year for investors in Innovative Industrial Properties (IIPR 2.50%) took a turn for the worse on Friday after the marijuana real estate investment trust (REIT) disclosed the default of a major tenant. Shares of Innovative Industrial fell 13.9% in Friday trading as investors consider the fallout of that revenue going up in smoke.

So what

It's been a tough year for the marijuana sector, and the companies that do business with the sector haven't performed much better. Innovative Industrial lost more than half of its value in the first half of 2022, in part because investors were worried about the health of two of its top 10 tenants.

Those fears were well-founded. Late Thursday, Innovative said one of those tenants, Kings Garden, has defaulted on its obligations to pay base rent and property management fees for the month of July. The dollar amount totaled about $2.2 million, which includes about $1.8 million in rent and fees and about $382,000 worth of insurance premiums.

Innovative Industrial said in the filing that it's continuing discussions with the tenant on the leases, but has also commenced discussions with other operators who might be interested in leasing at least some of the properties.

Kings Garden ranks as Industrial Properties' fourth-largest tenant, according to Ladenburg analyst John Massocca, representing about 8% of first-quarter revenue.

Now what

One could argue the market is overreacting, since as noted the stock has been under pressure for most of the year in large part due to concerns this exact scenario might happen. However, the real fear is what could come next, and what Kings Garden's issues have to say about the broader marijuana market.

If the default is indicative of a tough operating environment for marijuana growers and retailers, the issues could spread well beyond a single borrower. If so, there could be more pain up ahead for Innovative Industrial.

Focused portfolios like the one run by Innovative do well in good times, but are vulnerable at times when the area they focus on is under stress. Investors would be wise to watch closely to see how the coming months play out for Innovative's top tenants.