The worst case scenario is for a person to be exposed to a preventable disease that is 100% fatal.

If I buy this property with owner financing for two years, to refinance at the end of the two and pay off the owner, what would be the risk that I am exposing myself to?

Exposing the LLC to future litigation / exposure issues?

Instead of trying to do it all, and spreading myself thin (not to mention exposing myself to more risks/mistakes), I want to focus on out-of-state investing in smaller markets - where entry level buy-in's are more reasonable.

In most states, clouding someone's title without a legal basis (which is what he is threatening) is a tort which will expose him to damages. 

By exposing the property to a MUCH wider audience through the MLS, it's highly likely that you would have found someone to pay more.Just because a property isn't up to VA/FHA/USDA standards doesn't mean it's unsalable. 

We are now leaning towards a propane system Like Ed Simmons mentioned.

I've read that to limit my risk, I should title them as their own LLCs or at least have a separate LLC for the properties so I don't expose my other assets (primary residence, retirement, etc).

This will leave them exposed to your success/failure with their existing client, so it has to be a winner on paper and in real life. 

Thus, they may have unwittingly also exposed their broker to your lawsuit as brokers are technically responsible for all real estate actions of their agents.