I may lose the deal because I might be competing with a retail buyer but it is what it is

An election can be made to move the $5k and the associated interest over to Sch A so you won't "lose" the decision in that manner.But if you can't find a way to apply the capital in a feasible manner, don't make a hasty decision simply for a $225 write off.

Worst case scenario, don't get paid for 3 years and have to spend some money to foreclose.How can I lose?

Don't lose that positive attitude and keep moving forward!

It seems a shame to lose the whole deal and over 1k between my EMD and ext. fee all because of these technicalities.Any advice would be greatly appreciated.  

My original plan was to purchase a lake front home for personal use/short term rental, with the emphasis on the latter.

Then as your more familiar with the area and maybe even lock up a willing seller with a long term contingency, do another round of 1031s into the ideal property then.That way you don't buy the wrong property but you also don't lose the tax deferral.

so you could lose $30 - $40,000 above the value by doing the work and holding costs during that time, or lose $20 - $30,000 selling it to an investor for $10-$20,000. how much more are you willing to lose on the property just to hold it ?

Talk to people, ask questions, impress them with your willingness to work and learn.Remember, you will sometimes lose money, it's a shock the first time it happens.  

You should also consider that things can move in the opposite direction and potentially you can lose a that investment just as simply, so it is a riskier investment.