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How does the living system work? I am under the assumption that girls hailing from that town can only live there and that I could own multiple houses at once if they were in different locations but to my surprise the game doesn't let me buy a small house in the next town because I have too many people from my first town.

Sorry about that, the message you received was an oversight. My intention is that you have a separate house in each town and whatever girls you have living with you in other towns should not impact that in any way. I'll get it fixed.