Based on your description, Party 1 seems like the safer choice.

Being new I would suggest started with existing builds but building small multifamily in a small town with a rental shortage could be a smart move (someone's gotta do it).

Hey @Brett Riemensnider,A HELOC could be a smart move if you want to tap into your home's equity while keeping it.

If not, ride out the 12 months with the hard money lender.People have to make good choices and not over extend themselves just for the sake of buying something they really can't afford or that doesn't make good cash flow.

He had no choice but to begin selling off the portfolio.

At the beginning, it may be difficult to get a more expensive property that will appreciate well and so your choice is go with the cheaper property and get cash flow until you can sell and upgrade, or wait for a really good deal which you may be waiting for quite a while and its possible that you will have spent so much time waiting that you could have purchased multiple cash flowing properties by the time you get a good appreciation deal that you can qualify for / refinance after the rehab. i know anyone can go out and get seller financing deals, HML, flip to build capital or whatever the case may be I am just saying sometimes those will be harder and could result in less deals overall. 

If you're eligible, a VA loan is your best choice since it requires $0 down, no PMI, and allows multi-family properties.

Investing out of state could be a smart way to find better cash flow in more affordable markets.

Consult with competent legal counsel to guide you regardless of your choice here.

Depending how much of the neighborhood is a hot zone for renting rather buying, and which Property type is performing better than the other (meaning 1bd 1ba 2 floor renting out faster and much more consistently than a 2bd 1ba 1 floor), you can make your choice of those factors as well as other ones that impact your decision for what you wanna do with your investment.