And since they are now paying for their utilities it would be no skin off owner's back. 

You do NOT need to explain your difficulties, just ask to remove the penalty.If they refuse, then you might need to go a more complicated route: request a penalty relief based on a "reasonable cause" - which your family emergency might qualify for.

I know it's possible to convert a basement into a bedroom, but I've heard that it can be difficult.  

Appraisers generally have no skin in the deal so there's no reason for them to do anything but appraise. 

A HML wants the investor to have skin in the game.

180k for 6-7 bed homes has to be in a rough area(south or west side of downtown)Don't underestimate the difficulty of managing rentals there as well as living there. 

Start easy with something relatively turn key and gradually increase the complexity / difficulty of projects so you find their limits in a manageable way.

Not many hard money lenders will do that.Most do 75% of ARV and they want some skin in the game.  90% purchase 100% rehab but you better have a proven track record.Its best to find another partner to bring into the deal and quick.

The fact remains that you have no skin in the game beyond your reinstatement amount.

I assume you know the difficulties of that.