Fictitious place names are, of course, one of the novelist’s most transparent devices for incorporating fact into fiction. The elaborately coded topography of Hardy’s Wessex, for instance, or Arnold Bennett’s Five Towns, is not designed to deceive anybody as to the real locations of their novels, but to avoid the logical contradiction, and perhaps legal risks, of putting fictional characters in places that at a given time were occupied by historical individuals. The implied rules governing this matter cast an interesting though indeterminate light on the relations of fact to fiction in a novel. You can invent an imaginary London street, but you cannot have a capital of England that is not London. You can have an imaginary Oxford or Cambridge College, but it would seem awkward, to say the least, to have an ancient English university that was not Oxford or Cambridge. You can site a university in a city that doesn’t actually have one [...] You can, it seems, have a provincial city or town with a fictional name (Middlemarch, Casterbridge, Rummidge) occupying the same geographical space as an actual city or town, and closely resembling the original in every respect except inhabitants.
(From “Fact and Fiction in the Novel” in The Practice of Writing (1996).)
I’ve given some thought to the pros and cons of fictitious versus existing settings in connection with my own work. Initially, the idea of creating a fictitious city seemed enormously liberating. Just plunking things down wherever you need them. Not waking up in the middle of the night just after you’ve sent your story off to a magazine realizing that there’s no way that your character could have turned left onto Fourth Avenue since Fourth Avenue is a one way street that runs in the other direction.
But on further reflection it seems an extraordinary amount of work to create a whole city from scratch. Creating a coherent plot is difficult enough without having to create a coherent geography as well. I have enormous admiration for writers who are able to pull this off. The ultimate example is J.R.R. Tolkien who didn't just create a coherent geography for Lord of the Rings but also the various languages spoken by the characters that inhabited it. Of course, one doesn’t have to go to such lengths to create a fictional city located in an existing geographical space. But the prospect daunts me nonetheless. Even when my setting is an actual city that I know well, I have to consult a map to get the details right. I’m not sure that I’ve got the sort of spacial imagination that is required to map out a whole city of my own. I suspect that, at least as far as my realist fictions are concerned, I’ll stick to actual cities with the odd fictional street, university, restaurant, or bar dotting the landscape.
When one departs realism, of course, Lodge's rules no longer apply. For example, in an alternate history, you certainly can have a capital of England that's not London. However, the challenges associated with the creation of fictitious places remain.