In the entry we made about the end of Prison Island we did encourage players to have their characters work on building a new prison if they wanted to. That prison would be run purely by citizens with no Deity involvement as they built the last prison and felt it was a Bad Experiment. So citizens may build a new prison but as you said it must be done from scratch or they may remodel an abandoned warehouse, abandoned slaughterhouse, etc.

Regarding the size of the prison though, the old Deity-monitored prison was large and Alcatraz in nature. A Citizen-run prison would have to start much smaller, being more like a jailhouse than a prison, but if players and characters run it for a while it definitely can grow in size as time goes by.

And yes! Location should be on the outskirts of the City.