I think the frame you have is not designed for 27 inch, but 700c wheels, which is what you suspected. The slightly smaller diameter will give you an extra 1/2 cm or so width, which is why the brake pads are high up, and why the rear tire is nearly touching the seat tube. The Vitt. Zaffiros come in 27 x 1 1/8 inch for just $13 each from Nashbar. And if they don't fit, that's really means you have a very tight frame. But from your pics, it looks like even the original rims are a bit wide. Probably more than 25mm width. If you're looking for a low-cost solution, some Alex RP15F wheels with 700x28c tires might be the ticket.