We sponsors have enough advantages, so whenever I can make a simple decision that favors the investor, I will.If your waterfall is calculated on IRR split tiers instead of an annual return, the order is moot because “return of” and “return on” are treated the same, without any distinction, simply by definition.

After running the numbers, I can get a positive $2400 annual cashflow and a 9% ROI with a 20% downpayment. 

Instead of letting the house fall apart over time and be a tear down eventually while he might struggle to make mortgage payments that whole time, you might just being giving him a way out that is mutually beneficial.If you are ready, @George Munoz and @Scott Wolf gave solid advice.

Overall the structures seem to be sound (inspection next week should tell us a lot more), and it appears that most of the routine and annual maintenance has been done to AC units and other aspects. 

You have to remember the "1% rule" is a 12% annual return, quick numbers, and you have some expense to pull from there.

The property was valued at $67500 in 2010, annual property taxes of $1300.

This property has return a 21.74% annualized rate of return over the last 28 months.

This property has return a 22.13% annualized rate of return over the last 24 months.

I don't have to submit my tax returns and PFS annually either... just every time I apply for another loan.

Given your numbers and including the $500 annual repairs, you're still +$171 a month.