The Neutral faction comprises of cities that are unaffliated with a Great Mage. They are hostile to all Great Mages as well as to the Nature faction, but not to other Neutral units and cities. When a Great Mage's capitol city is taken, all other cities that Great Mage has previously founded or conquered are assigned to the Neutral faction. This faction can be identified by a grey color code.
The Neutral cities that appear on the map can be of a different race than your chosen Great Mage. Capturing them will give you easy access to settlers of that race, allowing you to build cities of a different race. This is useful when there are particular units or buildings that you wish to get from this race. However, it may be wiser to raze these captured cities to the ground if they serve no particular purpose, and found a city of your own race in its place. This is because the generation of gold, food and mana carries a penalty for cities of a different race, which means that controlling many cities not of your race will cause you to generate less resources than you would have with a city of your own race. In other words, you should be careful about deciding to keep all the Neutral cities you capture.