I don't see an issue regarding the owner-occupancy.

Owner occupant/residential?

I did a little research on the grants here in Baltimore, but it seems that most of them are for owner/occupants.  

If they do not take occupancy by the move in date, then the holding fee is forfeited.I also only do month to month rental agreements with 30 day move out notices.

If I'm understanding your question correctly, it is always better to have more bedrooms and higher max occupancy than having an extra bathroom!

What I also found interesting is that an investor, not an occupant, was attracted to your property at a price that appears would have been retail. 

One place I lived had a 50% owner occupancy rate, meaning 50% had to to be owner occupied.. so it's kind of a gamble, do other owners live there or not?   

but generally speaking it's that brokerage & occupancy piece that can trip up someone who treats a commercial revitalization as though it were a 'simple flip.'  

That said, by adding the basement as living space to the first floor unit, you are not asking for a change in legal use, but you are (officially) altering the building in ways that will affect it's potential occupancy (and you will need a Certificate of Occupancy from the city before you can move in, rent, etc).

What do they see them selling for per unit, what is the market occupancy rate.