Your friend shows good sense and should maybe find a different advisor to help him find money.Knowledgeable private/hard money lenders understand that owner occupancy has virtually nothing to do with making a business-purpose loan.

I was wondering if I paid the $29,000 difference(not including my percent down) could it still be eligible for a conventional 3.5% down FHA Loan?

It's not just an income map, it uses about 50 different data point (median household income just being one of them).

Just adjust your numbers on your offer to account for the difference.

If they're only approved for a $1,000/mo voucher and the tenants wants to apply for your $1,350 unit, the tenant will be required to pay the difference themselves.

That's no different than a w2 job that gives a paycheck.

As for financing, just to be clear, a line of credit and a 203k loan are two very different things. 

I've thought of 3 different approaches - 1. co-borrow...multiple parties on deed, entitled to % rent & depreciation based on investment, have "access" to property2. co-sign...multiple parties not on deed, negotiate % rent & depreciation based on investment, no legal access to property3. side-deal...parties gifts the down payment, operator must qualify for loan, all other details TBDAre there more approaches/options?

The amount of rent is based on the AMI which can be found here in this handy chart:https://www.sandiegocounty.gov/sdhcd/rental-assistance/income-limits-ami/so the calculation looks like this:For a 1BR unit (2 person household) at the very low income level you could charge a max of 1/12 of 30% of $48,500 or $1,212.5 per month.Also, in the agreement that I've seen (which was for a different City in CA) there were some restrictions against students.  

[3] Will buying the 1st loan trigger a foreclosure by a 2nd note holder, meaning will I need to pay off both 1st and 2nd to assume ownership; would this differ by state such as Texas or California or Florida (???)