Python: Parse file for a string and return value as variable

file is a string, containing a filename. As such, iterating over the string gives you individual characters, not the contents of the file:

>>> file = 'foo'
>>> for line in file:
...     print(line)
... 
f
o
o

You need to open the filename to get a file object:

with open(file) as fileobj:
    for line in fileobj:

Note that the '...' literal string syntax already produces a string object, there is no need to pass that to a str() call.

I'm not sure by what you mean with storing the found message as a variable; you already have access to the line variable, so you could just return that:

def get_version():
    logger.info('Started')
    version = None
    for file in os.listdir(running_config_dir):
        if file.endswith('.config'):
            with open(file) as fileobj:
                for line in fileobj:
                    if 'string1' in line:
                        print(line)
                        print('Found string1')
                        version = line.strip()
        else:
            logger.critical('Running Configuration not found')

    logger.info('Finished')
    return version