If I plan on picking it up as a buy and hold rental and I can generate positive cash flow at $135, even though its over the FMV, would it make sense, given the time, headaches and complications of a short sale to pay what's owed or should I offer the $125?

To me, it seems like a complicated math question. 

@Bob Romano If the house took a month to sell, then I would fix all the items she's requesting if none are overly complicated or too involved to address.

This can complicate things.Don't underestimate the financial and time commitment to getting your license.  

It doesn't have to be complicated.

Slightly complicating matters is also selling our existing home.

Power of Attorneys for ailing old people can get extremely complicated, and the entire transfer could be voided by a strong Elder Law attorney if the old person decides to renege and uses then existing mental condition to challenge the transfer.

I don't want anything complicated like AutoCAD or SketchUp.

My answer is a bit more complicated than it should be.

Many of these properties have complicated scenarios such as deceased owners, missing owners, judgments, etc. that require title-clearing and/or probate skills in order to complete the purchase prior to sale (or suction timeline).