I am wondering if prefab or stick built would be the way to go.

Usually the numbers don't work to build in these neighborhoods, unless government tax credits, etc.CCLBA has really cheap parcels for sale for owner occupants.

Did the proceeds from the sale count as short term or long term capital gains?

The reason is the rent-to-price ratio is good so you can cash flow, and most of the West side doesn’t have a Point of sale inspection which is really annoying.   

For the son to qualify for the $250k exclusion, I believe he would most likely need to meet the ownership and use test, meaning he needs to own and live in the home as his primary residence for at least two of the last five years before the sale.

@Jared CarpenterPhoenix is a strong market for home sales and the competition has been pretty strong for the last few years now as the markets have recovered greatly from 5-6 years ago.

At a 7% annual return, this could grow to $908K after 10 years, providing immediate liquidity and diversification.Alternatively, holding the property could yield $825K net equity after taxes in 10 years, assuming a $900K sale, with the potential to defer taxes via a 1031 exchange if reinvested into another property.

Would a low enough sales price make all of my concerns go away?

I have the credit, experience and the knowledge on how to underwrite the deal to show their ROI in this arrangement vs a traditional sale. 

It is much more difficult to sell an entire portfolio that has become uninsurable (which would require a cash only sale) or that insurance rates are so high that no one wants to buy.