It would be a good idea to assess your tolerance to risk and then plan something like that, but using a heloc is going to be around 9-11% in this market so to pay something off with lower interest rate to borrow more might not make much sense.

The importance of lowering expenses and increasing efficiency to maximize property income.

As far as what to tell them, you simply say that you're listing it for $1,700/month and are not willing to lower the rate.

Regarding price, do you have any suggestions on how I can get him to agree to a lower price?

Suggesting to them buying their house for a wholesale range offer or lower dependent on the extent of the rehab, then having a contract in place that gives them a percentage of the profit to help get them back on their feet, paying off debts etc.

My guess solely looking at your numbers is that it's an older/distressed property which means you have to account for more costs in capex. 2nd thought being it's not in the best of neighborhood then you'd have to take into consideration lower quality tenants/ neighbors and maybe increase expected vacancy and late payments.

This lowered my cost basis per lot by 7k.

In my experience tenants on the lower end of rent tend to cause more damage than higher price tenants.

(I know, nothing is certain but just hypothetically) and all cash out loans are not created equal. if you have a lot of equity you can borrow up to 60% with the lowest rate possible, which would be close to a half point lower then borrowing up to 75% loan to value. 

If renters find out your utility costs are high, they will expect a lower rent to balance it out.