No. The hardship only applies to seeking within 2 years of buying. I didn't read your question closely enough.
Because house 1 has been a rental for more than 5 years there is no exclusion for the gain on house 1.
If you sold house 2, you would not qualify for a hardship since the kids are 3 years old so even if you bought house 2 less than 3 years ago it was not unforeseeble that house 2 might be two small. If you have owned and lived in house 2 more than 2 years you qualify for the ordinary exclusion if you sell now or if you rent it for less than 3 years before selling.
