They want security that you have the down and enough to cover the holdings costs and what you'all need for deposits on materials like cabinets/counters/appliances until your bank draws kick in.

My 5 unit in Bucktown has a gas bill of $95/month on the budget plan which covers hot water for all 5 units and the building laundry as well as for radiator heat in basement studio apartment and the common areas.

You can buy 1 house a year for the next 10 years and have them cover all operating expenses, debt service, and you monthly living expenses (provided you are willing to keep those down and don't try to keep up with the Joneses). 

Lastly a couple months of vacancy to cover if you loose your tenants.

Do you know how to screen tenants?  

Renting them would probably yield 1500-2000 which may barely cover the expenses.  

We have aprox 150-200k to work with, and are trying to generate $2500 a month in passive income (to cover our main mortgage).

Start researching and using all the resources at the top of the screen.

All he wants is enough to pay off the mortgage and for the buyer to cover closing costs.  

Consider this in the price you tell them, it should cover the taxes you will need to pay on it.