Crazy thing is that I found that in the 1257 AD mod that they have the basics of this very same thing already.
Any town or city can have a Manor built, it appears nearby. You go in and speak to an NPC to have things built and after a while, they appear...and it actually appears inside, you can go to it. as you build, more building options open up and as time goes by the population increases and with it, the taxes increase as well. Some building options don't become available until a certain population total is hit.
So, seeing this I know the script already exists to have a settlement expand in all the ways necessary.
An addition like this can add an amazing aspect to the game, actually building your own empire from scratch.