From a purely conceptual point of view, here is what I see:
+ You seem to have bought your current town home when the housing market dipped. Hence the $100K equity gain. Selling it now is not a good financial move...people wait for years to build up such equity.
+ The housing market is on a big tear right now on the west coast...the prices have passed the 2007 bubble years by a mile in many areas of NoCal....you may want to check in your area. The conservative me says that the housing market has to come down...so, investing in a house is probably not a great idea. It all depends on where the market is in your area.
+ Your kids aged 10 and 7 are school going. Are you disrupting their schools? If so, then moving frequently may not be good for their schooling (imo). So, wherever you go, you may want to stick around for >= one academic year.
Considering the above, I like your rental option...wait for the market to go down...your townhome is earning its keep in the meanwhile. The only other option the conservative me sees is to stick around in the townhome until the market dips. In the meanwhile, save aggressively towards a home downpayment fund and when the market dips, buy your dream home in a down market, just like you bought your townhome. If you can sacrifice for a year or two, you may get a sweet deal that will set you up for life.
Hope it helps.