Having said that, there are certain problems inherrant to that sort of a mechanic...
Urban Sprawl, where player-placed buildings litter the length and bredth of the land to the point that no matter where you go, you end up in someone's front yard. It was an issue for Star Wars Galaxies, and it was an issue for Ultima Online before it.
Not only that, imagine how many cities would form in Tamriel that are not lore-supportive. Granted it could be explained that in the intervening centuries between the events of TESO and Arena, through countless wars and uphevals of both natural and un-natural causes, entire cities were razed to the ground. It would be a good explanation, and there are ruins all over Tamriel that might have once been part of cities or towns, the names of which have not survived the ages.
The big problem is Urban Sprawl. If a way can be found to avoid that, or if it proves not to be that big of a deal, then the notion of nothing outside canon cities surviving the later centuries can apply.
I had this idea that all canon cities would be hubs, with spokes branching off from them leading into neighborhoods or districts. Each one of these would have land where structures could be built. These would be separate zones. This won't be a problem if the streamed instancing talked about in the Hero Engine documentation on its web site is implemented. A city can sprawl as much as it needs to.