I told him that I did not believe his rights exceeded my existing tenants rights and they rented a unit with a yard for their children to play in that was listed as animal free. 

Here's the official description: Section 203(k) insurance enables homebuyers and homeowners to finance both the purchase (or refinancing) of a house and the cost of its rehabilitation through a single mortgage or to finance the rehabilitation of their existing home."

If there is an existing mortgage on the house, who is responsible for it?

It would be nice to find a way to do this, but I understand cost and liability always come into play with the business atmosphere we exist in today.  

When the existing tenant moved out there were some scratches in the hardwood floors, some light, some medium, and a possible gouge.

What exists is prior case law (precedent) where housing court judges are actively throwing out eviction cases when an attorney is not representing the LLC in court.

The owner found out that the ratio of profit to work involved is going to be much smaller, or non-existent, than he thought, and has lost interest in the property.3.

My idea was that down the line I would demolish the existing house and build a MFR since it's zone for that.

Low down payment options exist and there is much less risk.

After a few years of existence, the typical HOA winds up with mostly disinterested owners who will not show up for the annual public meeting where HOA officers are elected.