Personally I would do the cosmetic improvements and sell it now while it is vacant.Since you have $150K in equity with a opportunity value of a minimum 10% return although you may be saving the mortgage interest amounting of $625 per month you are losing $1250/month based on opportunity value for a net loss of $625/month.

The difference in equity is a lot to you, but depending on how the capital structure of the lender looks, it's just not worth the extra work to maximize this deal.That said, why bother using commercial at all?

The tenant could have bought a nice house for the amount he spent in rent and a good chunk of that money is now ours, in equity in the house.

Also- I have about $20k in equity between 2 properties.

.$470 K in equity is costing you lost opportunity income of $3900/month (10% value).

I think the best option is a private lender to float this until we can refi in 6-12 months to capitalize on the built in equity at purchase and value add opportunities.I'm interested in this Fannie Mae pilot program you mentioned though, will be sure to look it up.

I recently came across a list of leads being offered by a realtor of short sale opportunities where the sellers were being foreclosed on while having tens of thousands of dollars in equity with the home.

Run your cash flow numbers over the next few years and see how long it takes you to hit 20% in equity (don't forget transaction costs), and there is your target date for the refinance.A 4-plex is considered a residential loan vs. a commercial loan for your 40-unit, which are structured very different and won't have as many low/no money down options.Sounds like a great opportunity! 

I will adjust my cash out (cash remaining in equity) to an extent to get above that amount.  

Payments are currently $800 a month...she has about 50k in equity in the house.