I'm hesitant to set a utility cap, as I worry that disclosing a specific amount (like $500) could deter potential tenants.

Find the potential quite appealing.

The second option is to sell and house-hack a fourplex, which offers more units, higher potential cash flow, leverage equity, and appreciation potential.

Additionally, there’s always a risk that any pet-related damages could be hidden under furniture or otherwise concealed, potentially leaving us to cover the costs if the security deposit is fully depleted by other expenses (e.g., damages or unpaid rent).

2.What are the best and most cost-effective solutions for managing this potential long-term issue?

One of the potential advantages of property managers is access to the vendors they use. 

But of course, they are expensive and can hit you with a special assessment if they're not well-capitalized4.

If so, do you have any paperwork that supports the vesting to be able to show a potential lender? 

That's why there's a lot of appreciation potential here and cashflow.

Umbrella insurance can be a smart way to shield yourself and your partners from potential risks that basic policies might not cover.From what I’ve heard, local insurance agents familiar with investment properties in your area are a great starting point.