You're certainly free to reach out to the police, but I doubt anything will happen, and there is no need to "document" or value in "documenting" what happened.

Note that California has no law regarding "blackmail."  Conduct that would generally be considered blackmail falls under section 518 of the Penal Code, which provides as follows:  "(a) Extortion is the obtaining of property or other consideration from another, with his or her consent, or the obtaining of an official act of a public officer, induced by a wrongful use of force or fear, or under color of official right."  "'[C]onsideration' means anything of value," and "fear" includes "a threat . . . [t]o accuse the individual threatened, or a relative of his or her, or a member of his or her family, of a crime," "[t]o expose, or to impute to him, her, or them a deformity, disgrace, or crime," or "[t]o expose a secret affecting him, her, or them."  Section 519.

The problem for you is that your neighbor doesn't appear to have made any specific threat.  For all you know, he's bluffing.

As you should be able to figure from what I wrote above, your suggested letter could be construed as extortion or attempted extortion.

I disagree with Zigner's assertion that "Making a threat to perform an act that one has a legal right to do is not extortion (blackmail)."  For starters, the video in question may have been illegally made.  But even if we assume it was legally made, if the video includes embarrassing information, the neighbor has a legal right to disseminate that information and/or the recording itself.  However, threatening to do it in order to obtain an advantage in a legal dispute is unquestionably illegal.  As noted, the problem for the OP is that the neighbor's threat was way too vague.

P.S.  I tried to include a link to PC 518, et seq., but I wasn't able to do so.  It's easily googlable if you want to read it.