It was a set. It had to be for the scale and function (with the puppets). You must remember, at the time this came out, Henson Studios employed some of the most talented set builders ever.
This is the same crew that produced the amazing sets for Fraggle Rock, as well as Emmet Otters Jug Band Christmas (among other things that are not well remembered from that era, like the Muppet Musicians of Breman).