While not completely covered, using a pergola might fit in with your roof line. [houzz=]

You have done a beautiful job of tucking plants into the crevices of your retaining walls. Your house trim color is perfect -- just slightly lighter in hue than the retaining wall blocks. First I would paint the big, flat gray wall slightly lighter than the blocks and slightly darker than the house trim. The concrete walk and stairs I would stain a mottled blend of the blocks and the house trim colors. Next would be to paint the railing black or the house body color. Now, think of the following as creating a light, airy trellise structure from the walk-level face of the (currently gray) wall to about 7' above the top of the wall (using 6x6" posts attached to the wall) with a corresponding line of posts sunk into the terrace level 2' in from the outside edge of the wall-attached posts. The inside posts would be about 6-8" higher than the outside posts. Put 4x4" wood to attach the outside line of posts to each other and do the same with the inside line of posts. Run wood pieces at the top of the two lines of posts from the inside line to the outside line at about a 45 degree angle. They would be cantilevered up at the terrace level. Across the top of the angled pieces create your top trellise boards which run parallel to the two lines of posts. OK. There you have your basic structure. You might want to extend the structure around to follow the street side of the terrace. You could then follow the suggestion of reom10 above about creating a bench-planter on the terrace side. Your spacing of the boards parallel to the gray wall and attached to the outside posts would determine how private you wanted your terrace to be. You might want to soften the terrace "floor" by using something irregular like flagstone with groundcover plantings between the stones. From the latticework on top of your structure you could hang seasonal flower baskets. Plant vines to go up the trellis and spill down the wall. How about planting a row of tall, narrow shrubs along the neighbor's fence above your terrace to help add to your privacy and make your yard feel less 'structured'? Or, how about patio table/s with umbrellas to block your neighbor's view? Anyway, you have a fun project ahead of you.

Hi, I know there are so many things to take into account and it's hard to get perspective from a photo. The white you can see is an extension with building paper, and the red is the existing building which is two story. The exterior is wide weatherboard planking, the windows are silver aluminium with very little trim. The doors in the front of the picture are French doors from bedrooms that will open to an enclosed courtyard ( yet to be built of course) The roof will be a light grey/brown but you won't see it much because of the flat roof style. There will be decking and ballustrades covering half of the new extension.

I agree with lefty. Really think you should cut back the area. Even if you don't pave in the degraded area just plant it will look larger. Two levels shrink the space one level feels more like a room. Also I can tell the fence is your neighbors because the rails are facing your side. I would face the fence so that it looks better in your side.