It sure does. She is currently putting a net $400/month into this mortgage that she would not be spending if she sold the house right now. That makes it a cashflow negative investment, by definition.
...the bottom line is that your house in Vermont is not a very good long-term investment as a rental property.
I have to disagree with you as well. As long as the rent covers expenses (interest, taxes, insurance, maintenance) - and it does, with $200 left over, than the $400 are going toward their principle - in effect they are building equity.
Take two scenarios.
1. Sell the house. As you mentioned, this will create a $400 positive cashflow (or closer to $550 if you add average repair and maintenance on the rental).
With the added $550, she'll repay the student loan in 22 months. While saving the $2450 for the next 6 months, after 28 months she'll have about 15k in equity.
Assuming house currently costs 210K, and the sale cost her 10%, she'll have another 24k earning her 7% annually, so another 3-4K.
Total equity - 15+24+3 = 42k
2. Her current plans. The student loan will be repaid in 28 months. During that time, she would have built 17k equity in her house. The house would have appreciated in value*. At a conservative 3%, that accounts for another 14k in equity!
If she sold the house at that point, it would be worth 224k, and she would owe 147K on it. If we deduct 10% for the selling cost, we'll get: 224 - 148 - 22 = 54k So she's 12K richer this way -that's a good incentive to keep the house for now!
If she decides to move back to VT, the incentive is even bigger, since she wouldn't have lost that 22k to realtors and title clerks.
In summary, you're doing well, keep it up!
* Most people who own highly mortgaged property are actually margin dealers in the real estate market. This would scare most people if this were stocks, but is brushed off for real estate. You need to realize you are in a volatile position, even if it's a good decision long term.