I own rental properties in one city and two of them had insurance claims in the last 2 years due to hail and tree damage.

Hi,Regarding your questions:#1) I highly recommend you consult with a licensed insurance professional in your area, especially one experienced with landlord-specific insurance.

I just lost ONE FULL YEAR OF NOI on the 3 years leased to that tenant. 

This does require owner occupancy of both units for at least a year for condo application submission, but also assumes a number of other things including that nothing was performed with respect to prior historical tenancies that would disqualify you from a condo conversion.While the aforementioned would be ideal, it would be all for naught if Planning determines that if at any one time the ground floor was rented in the past.

The rental income will more than cover the mortgage and still provide positive cash flow, which is rare in the California market, making this a great opportunity for us.However, underwriting has expressed concerns about us moving from a presumably larger home worth $606,000 to a smaller one worth $376,000.

One property is the residence of the owner. 

Maybe one of you can help....I run a property management company.I have a new prospect that wants to go through with a contract.

That would work.But, if you've already invested a year in that as a primary residence then why not stay there one more year and take the gain tax free under sec 121 the primary residence exclusion. 

It will also hopefully help to get some equity partners in the near future so we can get the ball rolling again on our fix and flips.  

This is a hard one!