3 Financial Stocks That Could Be About to Benefit From a Rate Cut

Key Points

• The Federal Reserve is in the middle of a delicate tango between inflation and interest rates.

• The most recent rate cut was modest, and Wall Street seems to believe it was just the start.

• Rate cuts could be a big benefit to financial stocks like AGNC Investment, W.P. Carey, and Simon Property Group.

• 10 stocks we like better than AGNC Investment Corp. ›

One of the Federal Reserve's mandates is to fight inflation. Recent research from The Motley Fool highlights that inflation has a long history of ravaging the savings of investors and, sometimes, battering the stock market as the buying power of a dollar shrinks over time.

Rate cuts help by supporting U.S. economic growth, which leads to positive things, like pay raises. Rate cuts also help businesses like real estate investment trusts (REITs) AGNC Investment (NASDAQ: AGNC), W.P. Carey (NYSE: WPC), and Simon Property Group (NYSE: SPG).

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AGNC Investment's costs go down

AGNC Investment is a mortgage REIT (mREIT), a niche of the broader REIT sector. It doesn't own physical properties but buys mortgages that have been pooled into bond-like securities.

High rates can have a damping effect on the housing market, which ultimately reduces the supply of mortgages. So falling rates might give AGNC Investment a broader pool of investments to purchase.

That's good, but the really important factor here is AGNC Investment's own debt costs. In an effort to increase returns, the mREIT uses leverage. Essentially, it takes out loans backed by the mortgage-backed securities it owns. The rates it pays to borrow change along with interest rates.

The big direct benefit from falling interest rates for AGNC Investment is that its costs decline. That can help to widen the spread between the interest it earns on the mortgage securities it buys and the interest expenses it faces. If the housing market heats up, too, all the better.

Lower costs will help W.P. Carey, too

The drop in interest rates will also help W.P. Carey afford to keep expanding its portfolio of physical assets. This REIT has a diversified portfolio of assets but is heavily focused on industrial properties. It uses a net lease approach -- in which tenants pay most property expenses -- often acquiring properties in sale/leaseback transactions. These are basically financing transactions for the seller, which may need cash for other purposes (such as expanding its business).

W.P. Carey basically is taking out loans and issuing shares so it can afford to buy properties. The company is using its balance sheet so the seller doesn't have to lever up its own balance sheet. The better the rates W.P. Carey gets, the lower its costs and the more competitive it can be when buying.

Lower rates could have a secondary benefit, too, given the REIT's industrial focus. If the Fed's rate cuts help to spur economic growth, then more companies will look to expand their businesses. That increases the opportunity for W.P. Carey to make profitable investments.

Shoppers may also go shopping more often

The last REIT is Simon Property Group, the largest enclosed mall and outlet-mall landlord. Malls are huge structures, and mall REITs tend to make material use of leverage, so lower rates will, like the REITs above, have the benefit of lowering Simon's costs. That's a very important issue, but the economic impact of rate cuts is probably the more prominent factor to consider with Simon.

When interest rates are high, it has a damping effect on the economy. Basically, if economic growth is slow, consumers often choose to shop less. When rates fall, economic growth is bolstered and consumers feel more confident in spending.

More spending means more people are going to Simon's malls, which can lead to increases in occupancy as more tenants open locations. As a side benefit, Simon also gets some of its rent based on a percentage of the sales its tenants generate. So more shopping can directly benefit Simon's top and bottom lines, too.

All in all, a stronger economy is good for retailers, and what's good for retailers is good for landlords like Simon Property Group.

Make sure you understand the REITs you're buying

Of this trio of REITs, AGNC has the highest yield at more than 14%. Before you rush out and buy it, however, know that mREITs like AGNC are complex and that the company has a history of cutting its dividend.

It won't be a good fit for most income investors, even though it will benefit from a shift toward rate cuts. W.P. Carey and Simon are far better choices for income investors, with yields of 5.3% and 4.6%, respectively.

Simon, however, has a habit of cutting its dividend during recessions, which makes logical sense for a mall landlord. However, the dividend has always come back strongly, eventually exceeding the pre-cut level.

W.P. Carey, meanwhile, just cut its dividend after a major portfolio overhaul. That move followed 24 annual increases. The dividend has been increased each quarter since the cut, though, so this REIT has gotten back on the dividend-growth path very quickly.

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Reuben Gregg Brewer has positions in Simon Property Group and W.P. Carey. The Motley Fool has positions in and recommends Simon Property Group. The Motley Fool has a disclosure policy.