I got word last night that the tenant's housing assistance contract with Section 8 has been canceled, so Rental #2 is no longer a Section 8 house. It also means the tenant will likely have to move out, since she probably will no longer be able to afford the rent.
The seller thinks the problem lies with letting the old property managers continue to manage the property for so long. They had told Section 8, they were the property owners and apparently also were slow to respond to Section 8's repair requests. So by the time the seller started moving the property to a new management company and discovered all the problems, there was not enough time to fix everything and get the house re-inspected.
The seller will be refunding my earnest money deposit. Hopefully, my mortgage broker has not yet had the appraisal done on this property, so I can get that money back as well. If not, I'll be out the $350 or so for the appraisal.
The lesson here is, even though you have a property manager, it still pays to keep a close eye on your investments.