I work a lot of short sales as an agent for my clients and have never seen the 2nd require the buyers to put up cash to cover the deficiency.

Reason I say that is if the bank forecloses, it will sell for less than a short sale - depending on the state they could seek a deficiency which the lender will pull his credit and see whats going on and find out more about this person.

We always try to point out any deficiencies in the home or neighborhood that would have an impact on the price, as well as supplying them with comps to support our price.

In most states, the public auction clears out any junior liens, but there are exceptions such as tax liens, which typically will continue to be in effect after the auction"They are transferring title via SPECIAL WARRANTY DEED, rather than TRUSTEE DEED,so there's this:Special warranty deed Arizona and junior liensArizona Revised Statutes33-402, Forms for conveyances; quit claim; conveyance; warranty; mortgage .... 33-723, Right of junior lien holder upon foreclosure action by senior lien holder ... 33-730, Limitation on deficiency judgment on mortgage or deed of trust as .... 33-1226, Easement to facilitate exercise of special declarant rights ...www.azleg.state.az.us/arizonarevisedstatutes.asp?

I see opening bids lower than the amount owed when the lender if also filing a deficiency judgment.

Assuming the monthly income is not sufficient on its own, their savings or other assets should offset the deficiency. 5 or 10K is NOT adequate, but depending on the rent, 50K might be; any anything north of 100K should provide all the security you need.You still do a credit check to make sure they are not maxing out credit cards to live on and see what their historical performance has been; and background check to make sure they don't have current bad behavior.

Local investors and active investors building in deficiencies elsewhere can make these work, but in cases of a true Turnkey property, I think these are bad investments.As for buying a property before renovation or even during renovation is a very bad decision.  

So I'm looking for some advice on which course of action you all would recommend:1) Keep the tenant (who wants to renew and has paid the rent), despite their maintenance issues and the rumors they're part of some drug cartel I hear from the neighbors... but get a new property manager or manage it myself if I can correct their deficiencies.2) Look for both new tenants and a new property manager (or do it myself since I did a better job vetting tenants to begin with).3) Sell it.

All the major MEP was marked deficient in the inspection report.

It seems much more likely to me that there is some deficiency in your offers than that there is some sort of shadowy conspiracy of insider deals.