Is option 1 just losing 5cm from the garden? If so I'd probably say fuck it and go with that. Maybe send something to your neighbour stating that the boundary is 5cm beyond the wall, as per the property plans, or something in an attempt to cover yourself.
Since you’re asking opinions.
I’d just have all the bricks bluff, with the roof and rear cladding matching it will look like it’s just been slotted in place and make the cladding even more of a statement piece.
I vote set the wall back, you can do whatever you like then.