If you want to keep it, then would you refinance that new build to pay back the HELOC? 

The long term (since 2000) appreciation for chicago is 3.35%/year.  3.35 * (10/6) = 5.58% return from appreciation.Total return: 5.58% (appreeciation including the leerage) + 2% (cash flow)= 8.58% + equity pay down + tax benefits.I fear your total return does not justify the effort and risk of residential RE.San Diego is a good market for long holds.

Great tenant that always pays on time - been there for 5 years Did you work with any real estate professionals (agents, lenders, etc.) that you'd recommend to others?

My plan is to buy the house subject to their existing mortgage, renovate the property, refinance it and pay off their remaining loan balance using the money from the cash out refinance.

what would be the justification for paying that much?

Sometimes it's better to pay a bit more, for a real professional to handle your most important transaction. 

For small MFH/SFH you have to find the deal, inspect, estimates and decide what to do, make a deal, get financing, get contractors, manage contractors, pay contractors, then turn it over to a property manager.

They are great sellers, but then want you to pay extra pretty much for EVERYTHING!  

Keep in mind if you buy another primary residence, you'd have better rates, terms and can pay as little as 5% down for multi family up to 4 units.

As @Dan H. has stated building and ADU can take a while to pay off and could affect the appreciation on the exit sale without a garage which could limit your sales to another investor.