Further, many are using shorter term, 5 year balloon, bank debt. 

I can see the growth with all the new banks opening up.

We are leaning toward shopping for a mortgage from a bank. 

In the case of the big banks, i could see how they might not get the POC filed in time, which screws over the borrower since they can't include that debt in the plan.In your case, you might have to wait it out.

The construction loans I know of require 10% down on the final price and they would want money in the bank after closing in case of cost overruns or the property not appraising for the build price.If I were you I would go to open houses of new developments in your area and check out the builders, and their terms. 

Should I open a separate bank account for all rental income and expenses that will occur?

But you'll get to establish a relationship with a local bank (or several) and potentially open the door to obtaining a business line of credit down the road once you have built up trust with the lender.

If your guy is preapproved for a loan, his bank most likely isn't going to fund the deal with income like this for the reason that you mentioned, free cash doesn't even cover debt service.

I see funneling income in this way as a form of paying yourself first and the bank last.

I had a similar question:  https://www.biggerpockets.com/forums/311/topics/588871-az-rental-friendly-bank-for-heloan?