I have a problem though, my DTI will not permit a new VA purchase, or at least that is what I was told from my mortgage officer.

Builders are licensed, get permits and do things properly.  

Soft Cost = Architectural Design Fee, Permit Fee, Holding Cost...Hard Cost = Grading, Concrete, Rough Carpentry...and if you don't know what to account for, simply ask.this website is great in helping people find answers.Cheers.

I decided not to do the deal due to some permitting aspects that would involve dealing with the city of Chicago and potentially tearing down the work of the previous owner (he started doing a lot of work with no permits and it wasn't to code).

Here are a few to start:1) Where are they in the process/timeline of getting approval to build (zoning, permits etc.)2) What measures of control are available to the investor(s) if the sponsors don't meet the milestones needed to complete construction and arrive at a marketable project.3) If there are delays, cost overruns etc., anything affecting the profitability of the project, Will there be an adjustment made to the profit participation of the investors?

We are still waiting for permits, but I'm getting nervous about this lien because it's substantial, equal to the cost of the property.

I was told I need to get a permit from the city...??  

@Jai Sookhakitchpermitting such a thing will be your biggest challenge.. most large quaries are owned these days by national type corporations that have millions and time it takes to get these permitted. 

That said so far he's done a good job (permitting, sub contractor recommendations), and my Dad who is in highway construction thinks he'll work well.

That would be the first thing I would consider if I were in your position.I am like you, if it is work that is not requiring a permit to do, it doesn't need to be done by someone with a license.