Figured it out. Had a subdirectory named files in the root. Fixed it and everything worked like a charm!
Yes they are on the server as http://realestate.smithsaga.com/wp-content/blogs.dir/11/files/2010/08/featured_1.png shows. However, when I check the media library, only a picture holder appears with no thumbnail. So I would guess that they do not show. Then when I drill down, it takes me to the picture as http://realestate.smithsaga.com/files/2010/08/featured_1.png and I get a 404.
Yes pretty permalinks work.
