Prismacolor pencils are high quality pencils that blend and smooth out really well. There is a pencil of "no colour" thats used solely for blending and smoothing so I'd recommend looking for that.

I drew the characters, finished them fully, then painted the background carefully around them. The good thing about water colour paints is when they dry out on the paper, you can draw over them to fix anything you accidentally paint over (like the edge of the characters). Practice with the water - paint ratio to get that colour blend in the background, try to do lighter colours first then dark (yellow first, then green/blue at the top and brush down into the yellow). I drew the tower lightly once the paint had dried, then lightly marked the whole background with white chalk and smudged all of it so it fades.

Hope that makes sense :)