patrick.net

Sell it?

It's the same house as it was when you bought it for 1M. From your question, it seems like it was worth paying a 1M mortgage to live in it in 2009. OTOH, you now have two new options: sell it for 1.75M or rent it out and rent a smaller unit.
Option 1: Stay in house - no new capital/revenue.
Option 2: Rent out house and rent a smaller unit. Presumably, your out of pocket expenses go down, by a fixed amount, but you have less space.
Option 3: Sell house, and buy / rent smaller unit.

Option 1 & 2 are easy to compare. Just look at the reduction in monthly living expenses and decide accordingly.
Option 3 is harder to compare, as this is an investment decision. If you think that housing is getting overvalued again and want to protect your 'gains' against a potential downturn, then sell it. Otherwise, pick from options 1 & 2. The risk in selling is that if housing prices continue to go up, you are stuck paying whatever rent the market bears.

If you are young and like the area, the conservative option is #2. You always need to live in a house, and assuming no depression style deflation event, you are better off owning one house.

If you are old and want to retire elsewhere, selling and downsizing is the conservative option.

Is your assessment about how much you'll be ahead accurate? A good number of properties seem priced above what rental income would cover. And can you cover two payments if the property sits vacant?

It depends on how you have invested in the house. If it's 20%, then you've basically got a $200K bond paying $1K/month or $12K/year. That is 6%/year. Which isn't horrible if that was guaranteed passive income, but in this case it's not. There is risk of not being rented, risk of repairs, etc. I'd sell and invest the proceeds--you'll make about the same profit without some of the risk.

Sell it. Pay $500,000 cash for the town home. Blow the rest on hookers and coke.