As you may know, I'm currently the Lead Area Designer on Torment: Tides of Numenera, and I've also done writing and design work on a number of other RPGs, including Neverwinter Nights 2 and Fallout: New Vegas. Today I'm going to describe my approach to designing a city or town in an RPG (and along the way, reveal some of our initial design thoughts for WL3).
At the start of the design process, the first order of business is always research. I try to find out as much as I can about the town's existing lore, dig up any maps that might exist, and search out preexisting stories, characters, and landmarks that could spark fun ideas for quests. For example, when I designed the town of Mulsantir in Neverwinter Nights 2: Mask of the Betrayer, I delved into some really old Forgotten Realms sourcebooks, looked for references to the town, and jotted down notes on everything that sounded interesting. Partly this is to reward fans of the setting and surprise them with references to people and places they know and love... but it's also an effort to gather as much creative ammunition as I can. I find that my imagination works best when I have plenty of disparate elements that I can fit together in interesting ways.
