I am sure the neighbors idea of correcting the encroachment issue will be to either adjust the property lines or have the buyer agree to allowing the encroachment to remain. Lots of potential issues; unencroached land area, setbacks not only from lot lines, but also between buildings, street frontage, minimum lot width. How does the encroachment impact the buyers plans?
One of my first steps, before looking for comps, would be to research all zoning requirements, setbacks and restrictions. Then I would talk with the zoning administrator to see what his/her thoughts are and what if any approvals are needed. My guess is the lender will cancel the order when informed of the issues, unless they are planning on it being a vacant land loan, which will eventually convert to a construction loan.
Also, if the plan is to remove the existing improvements, not only is the purchase price part of the cost, but so is the removal of the improvements. Not a huge deal regarding the subject, but it could be if you find my comps where an existing structure was removed soon after purchase.