My concern with the home equity loan strategy is I'd still have the first home mortgage, the equity loan, and a new mortgage (albeit reduced from the down payment).

I’m mainly concerned about the rate change happening without prior notice, especially since both loans started and are closing on the same day.I’m scheduled to sign tomorrow and close on Friday.

I would leave 10K for anything that comes up after the fact. 40K would be 120-160K range on a SF.

Private money won’t take it because if I can’t refi it out they won’t get their $ back and I can’t ask my investors to do the same for the same concern.

City  can make you get rid of all tenants and leave it vacant until you put it back as permitted and get a new CO. 

Concerns: Although the cashflow is good, we weren't sure it's valuation and potential for appreciation since there is no good comp like this property in the area.

https://ktla.com/news/nationworld/airbnb-nightmare-tenant-leaves-los-angeles-home-after-nearly-600-days/#:~:text=(KTLA)%20%E2%80%93%20Elizabeth%20Hirschhorn%2C,according%20to%20a%20court%20filing.

My concern is that I might be over leveraging myself if I try pull out a 20% down payment for a DSCR loan.

That will leave you with limited funds to actually purchase the house.

If so, you may choose to simply add it to the lease as being damaged at move-in so the tenant doesn't get charged for it when they leave.