I had to confirm with my client this was true and made arrangements with her to pay the cancelation fee and terminate the contract.

We've considered all sorts of unconventional arrangements (e.g. buying a vacation home in Tahoe and continuing to rent). 

I am struggling on how to best structure the ownership arrangement as I am taking on the vast majority of the risk. 

Ignore what the water company is telling you.If the tenants do not like the arrangements allow them out of their leases.

MF is much more efficient and cash flows much better; it is great to have many tenants under one roof. 10% for PM is pretty normal; but watch the add-ons for getting new tenants and arranging calls, visits etc.

I am struggling with how to best structure the ownership arrangement as I am taking on the vast majority of the risk.

I was living out of the state at the time so I made a visit to the properties and arranged to have my father, a CPA, come and do an audit of their books for my account at the property management company. 

Just the one here on BP or is there a MLS/loopnet kind of arrangement for them?

Capital improvements should be an expense of the land owner as part of a lease option, otherwise you risk throwing that money away if you do not exercise the option.If the Seller's big concern is taxes go with a straight Seller Financing arrangement as it will provide the same outcome. 

He does all the work, arranges contracting, rehab, listings, renters, etc.