This work presents a new resource allocation optimization framework for cellular networks using neighborhood-based optimization. Under this optimization framework resources are allocated within virtual cells encompassing several base-stations and the users within their coverage area. Incorporating the virtual cell concept enables the utilization of more sophisticated cooperative communication schemes such as coordinated multi-point decoding. We form the virtual cells using hierarchical clustering given a particular number of such cells. Once the virtual cells are formed, we consider a cooperative decoding scheme in which the base-stations in each virtual cell jointly decode the signals that they receive. We propose an iterative solution for the resource allocation problem resulting from the cooperative decoding within each virtual cell. Numerical results for the average system sum rate of our network design under hierarchical clustering are presented. These results indicate that virtual cells with neighborhood-based optimization leads to significant gains in sum rate over optimization within each cell, yet may also have a significant sum-rate penalty compared to fully-centralized optimization.