The Federal Reserve began the process of cutting benchmark interest rates in September 2024, as expected. That came after a long series of rate hikes it initiated in early 2022 to help cool off surging U.S. inflation. So far, it has cut the federal funds rate at three consecutive Fed meetings. The pace of cuts is expected to slow in 2025, but the trend lower should continue.
Here are two stocks that should benefit from a falling interest rate environment this year — but rates aren’t the only catalyst that could propel them higher.
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“The Monthly Dividend Company”
When interest rates are declining, there’s typically higher demand for stocks in the real estate sector as lower short-term interest rates often correlate with lower mortgage rates. That helps explain why Realty Income (NYSE: O) shares surged from a low of about $50 per share in early 2024 to nearly $65 in October. But shares of the real estate investment trust (REIT) plunged from there as 10-year Treasury yields rocketed from below 4% to about 4.8%.
Even after three rate cuts totaling 100 basis points from the Federal Open Market Committee (FOMC) in 2024, the long end of the yield curve didn’t follow, and long-term interest rates raced higher. That made dividend-paying equities like Realty Income less attractive compared to bonds.
But Realty Income has much to offer, and the stock’s decline has created an opportunity for investors. Its dividend — which it distributes monthly, not quarterly — offers investors an income stream with a better return than long-term Treasuries even after Treasury yields have moved higher. With the shares recently hovering near $53, the annual yield is currently about 6%. Also, management has increased the dividend for 30 consecutive years at a compound annual rate of 4.3%, so investors will likely see another boost in 2025.
Realty Income has also proven it can grow its business in a variety of economic environments. Since 1996, it has averaged about 5% annual growth in adjusted funds from operations. Combined with a dividend yield averaging 6%, that has given its shareholders a total operational average return of 11%.
It is also diversifying its asset base as it continues to seek growth. It closed the acquisition of fellow REIT Spirit Realty Capital in an all-stock transaction valued at about $9.3 billion in early 2024. That helped to diversify and expand its U.S. assets.
It also started a joint venture with Digital Realty Trust to invest in data center development in northern Virginia.
The company has also been expanding its European real estate platform since 2023, when it acquired 82 different assets in five countries. It has a strong balance sheet with some of the highest debt ratings among S&P 500 REITs. Its liquidity and low borrowing costs will make it easier for it to continue to grow, and the stock is in a good position to rebound in 2025.
Energy pathway leader
Another dividend payer with a strong underlying business outlook is energy pipeline operator Kinder Morgan (NYSE: KMI). Investors have already recognized that it’s in a good position in the current environment, pushing the stock up by more than 55% last year. But the use of natural gas is likely to grow, and a falling interest rate environment should benefit Kinder Morgan.
The midstream giant either operates or has ownership stakes in a total of 67,000 miles of natural gas pipelines, giving it the largest natural gas network in North America. About 40% of the natural gas consumed in the U.S. is transported by Kinder Morgan’s pipelines. Natural gas prices have been surging as it has become apparent that the country will need to generate increasing amounts of energy to power data centers.
Data center construction has exploded to support the expanding computing needs of artificial intelligence (AI) software. Last year, Kinder Morgan also finalized an investment of almost $500 million to expand its Gulf Coast Express pipeline, which will increase natural gas deliveries from the Permian Basin to southern Texas.
It’s not just Kinder Morgan management that sees a long-term trend of increasing natural gas use. Constellation Energy recently announced plans to acquire privately held Calpine, in part for its low-carbon natural gas generation capacity. Constellation CEO Joe Dominguez acknowledged that renewable sources alone won’t be sufficient to meet the country’s growing energy needs.
Explaining why his company paid over $16 billion for Calpine and its natural gas capacity, he stated, “We can’t grow zero-emission megawatts that fast, to meet this growing [data center] demand.” Data centers also require a 24-hour energy supply, which renewable sources can’t always provide.
Addressing his long-term vision for the acquisition, Dominquez added, “The grid operators are saying they’re going to need natural gas at these volumes for decades to come. That was before we’ve seen these revisions for load forecasts.”
Kinder Morgan Chairman Richard Kinder agrees. In his company’s third-quarter report, he stated, “With substantial projected increases in natural gas demand both domestically and globally in the coming decades, we have many opportunities on the horizon.”
Investors started to recognize that last year, but Kinder Morgan is in a fine position to continue rewarding shareholders for years to come.
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Howard Smith has positions in Kinder Morgan and Realty Income. The Motley Fool has positions in and recommends Digital Realty Trust, Kinder Morgan, and Realty Income. The Motley Fool recommends Constellation Energy. The Motley Fool has a disclosure policy.