A duplex, tri-plex, or even four-plex would be ideal.

Would you factor in a rent cushion, if so how much?

Both have outlying areas that are ideal for what you're suggesting.

We factor in about 2.5% of purchase price for yearly taxes, 5% vacancy (ours is closer to 2%) 15% of rents for repairs and capex combined, we self manage so no PM, and use 2% for rent growth (ours is about 4%) and 2% for property value growth (ours has averaged about 3.75% in our area over 30 years). 

My opinion is that this is really a personal choice and a factor of you and your wife's outlook on risk vs. opportunity. 

Going in I knew it was tenant occupied but on a month to month (but paying weekly) and it was a fast close and typically I deal with any inherited tenant situation while still in escrow and have some kind of contingency/agreement in place for that but I bought through a wholesaler this time and it was basically a no contingency deal.

My saving graces are my house is in ideally situated between a downtown area, a college, medical school and a massive Navy Base with a solid rental history (knock on wood).

sounds like you have a great opportunity. i recommend the contact for deed route. as you mentioned you can get a lower down and more flexible terms. if you can get a 10-12 year ballon payment you should have no problem refi'ing out prior to that with a conventional loan and pay off owner contract. i would try to get the per unit down. you could try to show the total amount you would be paying when you add interest into the equation and see if he will come down on asking price, at least to market if not below. as well as play up the continued cash for with zero management headaches. ultimately if it cashflows well and you have good fixed debt for 10 plus years my experiences has been that price per unit is less of a factor. cash flow is king.

Waiving inspections can be a huge negotiation factor so I wouldn't suggest dismissing that idea for future contracts.  

Factor in things like a property manager, even though you won't need one up front.