Interesting Dilema-sell or develop?

[Steve Wick]

My wife and I currently own an SFR on a commercial lot in Davis, CA, free and clear. We have been using the home as a residence for 6+ years. The house was originally built in the 1930s but has been added onto and/or remodeled several times. Roof is over 20 years old, but not leaking. There are issues with electrical, plumbing and HVAC that need attention or will need attention in the near future. We are no longer in need of the house as a residence and are trying to decide what to do with it. I've thought of four options and am soliciting input on those as well as being open to additional ideas:

1) We can rent the house for about $3100/month to two small businesses (the building is configured in such a way that they would each have their own space). We have verbal commitments from both parties. Because there is no sub metering, utilities, city bill, etc would be included in the rent making our monthly operating expenses between $900 and $1200 including insurance and taxes depending on how much we save for CAP EX and ignoring vacancy (I'm looking at a three year time frame and could get the tenants to sign three year leases). Net would be $1900-$2200/Month. We would need to spend about $5000 to make the place rent ready.

2) We were under contract to sell to a developer for $720000 (net after closing $679000). They planned on raising the building and putting up four townhouses. The project met city zoning requirements, but Davis is notoriously tough to work with on infill projects so the buyer cancelled escrow before their deposit became  non refundable. They are still trying to get the project approved by the city, but we are no longer under contract.

3) We could develop the property ourselves with a similar project to the one above. Rough numbers would look like: 1,000,000 in construction costs to build four units. Approximate value of each unit would be 600K to 700K (based on comps) in current market conditions. Net after paying off the construction loan would be approximately $1-1.2 million, but getting the construction loan may not be easy and I'm not sure that I'm entirely comfortable with taking out that large of a loan. (these numbers are very rough)

4) We have several reputable and established developers that have expressed interest in partnering with us on a project similar to the one described above. Talks have been very informal but are something along the lines of we front the property, they pay for construction, profits are split. Again very  rough numbers, but could net us in the neighborhood of 1-1.2 million.

I'm torn on what to do because my back of the envelope calculations put us at roughly the same financial spot three years from now assuming a 6% cash on cash return of the $680K if we sold to the developer in number 2. The exception is number 1 which would only be 2.5-3% ROI assuming the property is worth $720000 and that to me seems odd... who in their right mind would get rid of a property that cash flows $1900-$2200 per month? And of course there are tax implications. There would be almost zero capital gains on the sale in number 2. Does anybody know what would happen to my wife's and my exemptions if we developed the property or partnered with a developer?

Very new to REI but have worked hard to be in this position and don't want to make a costly mistake. Any and all input is appreciated. Thanks