Your first mistake is fixing up a house that you do not own. That is on you, not on this "friend" of yours. My guess is, the friend would have liked things to work out differently, but knew her situation was dire at best, and at the end of the day, she is going to look out for her bottom line, not yours. Also, just because you entered into a written agreement that she was going to do a short sale means nothing. She has to have permission from her bank to do a short sale, she cannot unilaterally just decide that is how she wants to dump the property. Also, short sales take a lot of time, and most likely, her house would have gone into foreclosure before you would have gotten an ok or heard back from the bank at all.
I would find a new place to buy and get out of this mess. If you do keep paying her rent, be sure you have proof either by a cancelled check or a receipt from her. When the bank does take the house back, they may offer you a cash for keys deal. If they don't, legally you have 90 days to remain in the house paying rent to the bank before you would have to go. But, since you said you wanted to buy a place before the end of the year, I would start looking elsewhere now.