AppFolio Investment Management: Putting the ‘G’ in ESG technology

Michael Sebastian, industry principal for AppFolio, shares why data is the next frontier for governance innovation.

This article is sponsored by Appfolio Investment Management

Michael Sebastian

Traditionally, governance has been focused on how people in a firm are organized. This has made it less well suited for tech-based innovation than the environmental and social components of ESG. That is changing, says Michael Sebastian, industry principal for the property and financial technology platform AppFolio Investment Management, a one-stop shop for real estate investment managers.

How does technology help managers meet their governance requirements?

One of the toughest challenges for the industry right now is the data governance component of ESG. It is a big factor that we are solving for.

AI can be used to collect data on loan balances and property values, track investors through various legal entities, compile and distribute reports and even serve as a conduit for fundraising and waterfall payment distribution. As more tasks are automated, governance is increasingly becoming a matter of data management.

These features drive efficiency by automating much of the investment management process. We do this by better harnessing the same data that most fund managers have on hand already, collecting information that doesn’t necessarily agree and consolidating that data into a single place, so our clients know the value of each of their customers.

That can be valuable when it comes to investor relations and to fundraising. At the same time, investors can access their own data all in one place.

Having everything in one place is attractive, but how do you keep that data secure? 

Governance means a number of different things. It means your data is good, it means making sure the data is accessible and accurate, but also that your data is secure.

Some managers think they are safe because they are not using a system, or they have it in an offline Excel sheet in their office. But all it takes is one employee clicking a link in the wrong email and now they have ransomware and that investor data is exposed.

We handle very sensitive investor data in our system: accounting data, banking data, personally identifiable information. We have done a lot of work to makes sure this is all secure.

We have done bank-grade security audits conducted by outside consulting firms that attempt to ethically hack our databases and look for vulnerabilities in the code. It takes a lot of time and effort to do that from our IT staff, but we put in that effort for our clients. That is all part of governance.

How is that different from how managers have approached data historically?

I have seen it a number of ways. The most low-tech way would be collecting a number of PDFs and having somebody type those into a spreadsheet or a database. Then you need to have macros or something built in to normalize all the inputs.

Traditionally, that is hard to do and takes a lot of time, so we simplify that. Another way is to outsource these tasks, which is done by many bigger companies with more resources, but in those instances, they are still paying a human to type things that can be automated.

The third way is through enterprise resource planning systems, which are big, clunky and extremely expensive. Here is where they fail: they try to shove a lot of financial and property management data from spreadsheets, or even PDFs, into a system that has a whole bunch of rules to contend with. We have solved that so that we can get data in faster and not have a million errors every month.

How does your offering fit within the broader context of innovation in the proptech space?

Fintech and proptech have been around for a long time. There have been software systems in the industry for over 15 years.

Those used to be clunky, on-premises, big enterprise databases known as ERP systems. They handled accounting and property management and maybe a few other things. When they tried to go online, they kept the same database structure and just tried to put a web interface on it.

We had a third- or fourth-mover advantage, where we are able to take advantage of more modern development techniques. In addition to building a great software tool, we built a great engine for building software.

It is a modern way that develops faster, more efficiently, can iterate quicker and push out meaningful new features faster. You don’t need to be a rocket scientist. You don’t need to hire expensive analysts to run it. You don’t need to hire consultants that take 18 months to implement it. 

What would you say to a firm that was looking to develop its own solution in-house?

I worked with a client recently who was considering building their own software, and here is what they were up against. They would have to hire developers for $200 an hour, and they are always going to underbid on contracts, like every contractor does. Now the client is into the project for $1 million and it doesn’t work as well as off-the-shelf software.

Why? Because firms can hire two developers or a consulting firm and have them build what the manager wants, but firms don’t necessarily know what they want. Or maybe they don’t know what the best thing should be. Whereas we have an entire organization with hundreds of people, a support staff, developers, product managers, user experience designers.

Managers can’t compete with that. It would be like your typical Robinhood investor trying to go compete against a hedge fund; 99.999 percent of the time, it is not going to win.

There is always a return on investment by outsourcing this work, rather than building it yourself. Sometimes that return on investment is harder to quantify than others because it is tied to quality of life as opposed to strictly financial gain.

A small company may have only three or four employees. Practically speaking, they are going to have people wearing multiple hats and doing multiple jobs. When the company grows, instead of having to add additional people, that one person keeps doing their job the same way but more efficiently.

Additionally, we also see reduction in time spent on certain tasks. We have a client that used to take two weeks to get its K-1 reports packaged up and sent out to all their investors, because they wanted to be careful to avoid human error. We took that off the table and allowed them to do it in a day. That is saving real time and money.

How does the understanding of data governance among managers need to evolve in order to keep up with investor demand and rising risks such as cybersecurity? 

Software is going to be critical because a lot of the industry is five years behind the curve in technology. Firms are still using Excel spreadsheets and Quickbooks to manage their properties and manage their assets.

I have seen entire funds run on Excel. There is so much room for error there, which opens managers up to investor lawsuits. It is not transparent, and it is not efficient.

Speaking to governance specifically, if we end up seeing more regulation and more oversight into what is going on and in the real estate space, I don’t see any way that more transparency is not a requirement. 

Even today, managers are audited, they have to be able to prove their finances, their cap tables and their reporting. If they have a system to do that, it is going to really reduce their headaches and problems at audit time.

You need security to be able to prove to your investors, especially the younger ones, that their data is protected. That is going to be important when it comes time to raise capital and it is going to be important to retain investors, especially institutional investors, which are the ones really driving the governance issue. From them, it filters down to the retail investors, high net worth individuals and family offices.

Are most customers aware of the security risks related to data governance? 

With respect to security, they typically do ask about it, because it is important to them. Most are aware of those risks coming in.

But with respect to governance, we often have clients asking us to help them with it, but they aren’t typically thinking about it as governance, per se. It usually comes in the form of them needing help with asset management. But asset management data is a form of data governance, so it falls under that rubric of ESG.