1) DNN 4 can be used with DNN 2 and above, using it with DNN 3.5 requires some changes in web.config file, which are performed automatically, when a site is opened with VS2008.

2) yes, if they provide SQL Server or allow SQL Server Express as well

3) DotNetNuke runs as a typical ASP.Net web site on the server. You have access to all the source code using VS2005/2008

Ease of use.  If you aren't familiar with setting up DNN and/or with setting up web-sites in general, then a "one-click install" is very good for you.  If you are familiar with setting things up (and since you are asking this on the Dev forum, I'm guessing you are), then a "one-click install" doesn't necessarily apply to you.  Me personally, I love to have FULL control over anything I set up so even if a place offers to install it for me I'm going to want to do it myself.

BTW, I run ASP.NET 3.5 on the majority of portals I've put together and then 2.0 still on a couple that I haven't got around to switching.  I've noticed that for AJAX applications using MSAJAX they run way faster with .NET 3.5 than with 2.0.  That alone is incentive for me to switch all of mine since I heavily use AJAX on our intranet applications and am starting to move that way with my side stuff as well.