altCognito makes a good point - using a library is the way to go. But if was doing it by hand, I would use option #2 - create elements with DOM methods. They are a bit ugly, but you can make an element factory function that hides the ugliness. Concatenating strings of HTML is ugly also, but more likely to have security problems, especially with XSS.
I would definitely not append the new nodes individually, though. I would use a DOM DocumentFragment. Appending nodes to a documentFragment is much faster than inserting them into the live page. When you're done building your fragment it just gets inserted all at once.
John Resig explains it much better than I could, but basically you just say:
var frag = document.createDocumentFragment();
frag.appendChild(myFirstNewElement);
frag.appendChild(mySecondNewElement);
...etc.
document.getElementById('insert_here').appendChild(frag);
