What would you do?

Current Situation:

Combined household income: $160k p.a

IP 1 - 2-2-1 Unit in Western Sydney @ 84% LVR (Negatively geared $1200 per annum)

IP 2 - 3-1-2 House in Western Sydney @ 75% LVR (Cashflow Neutral)

Current Savings - $45k

2014 target is to buy PPOR in Northern Suburbs (Anything on the train line before Hornsby)

Option 1 - This is what we would wish to do. (I am sure you guys will let me know whether its a good or bad idea)

Sell IP1 which will leave us with $55k approx (after allowing for capital gains tax and selling expenses) plus savings $45k will mean that we will have around $100k to play with.

Would you guys recommend buying a knock down rebuild project? Rent it out till DA approvals come through and also till we save up another $50k (lets say 12 months).

Purchase Cost - $800k (Pennant hills, Beecroft, Thornleigh, lucky if I could get something in Pymble, Turramurra, Wahroonga)

Building and Holding Costs - $500k (max) (Of course back of an envelope)

This way we will atleast be able to build a brand new house rather than paying $1.2m upwards for an existing home which maybe 10-15 years old

Option 2 - Selling both IPs will leave us with $150k approx, and buy a knockdown rebuild project as mentioned above. (Not a preferred option since we would like to hold IP2 since it is Cashflow neutral and has had solid growth recently)

Option 3 - Sell IP1 and buy a Unit in Northern suburbs. Save up a bit more rather than taking on a herculean project like this. Having said that, If the prices shoot up further, we will never achieve X% savings to kick of the project.

Option 4 - Continue buying IPs using existing savings and rent a 2 bedder until we reach the magic figure to kick off the project.

Whilst I understand a lot depends on personal circumstances and goals, however I hope I have given you enough info so that you'll can give some recommendations.

Thanks in advance for your feedback.
To buy an $800,000 house you are going to need around 10% deposit and around 4% for fees and costs.

Say $120k
You are going to be geared at 90%.
It is going to be very hard for you to do such a project at this stage