diff --git a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipInterface.h b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipInterface.h
index 8412361657..a26c3b0ecf 100644
--- a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipInterface.h
+++ b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipInterface.h
@@ -56,5 +56,7 @@ namespace AzToolsFramework
         
         virtual void StartPlayInEditor() = 0;
         virtual void StopPlayInEditor() = 0;
+
+        virtual void CreateNewLevelPrefab(AZStd::string_view filename) = 0;
     };
 }
diff --git a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.cpp b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.cpp
index 97c3041de6..b2b36cc318 100644
--- a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.cpp
+++ b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.cpp
@@ -225,50 +225,19 @@ namespace AzToolsFramework
 
         m_rootInstance->SetTemplateSourcePath(relativePath);
 
-        bool newLevelFromTemplate = false;
-
         if (templateId == AzToolsFramework::Prefab::InvalidTemplateId)
         {
-            AZStd::string watchFolder;
-            AZ::Data::AssetInfo assetInfo;
-            bool sourceInfoFound = false;
-            AzToolsFramework::AssetSystemRequestBus::BroadcastResult(
-                sourceInfoFound, &AzToolsFramework::AssetSystemRequestBus::Events::GetSourceInfoBySourcePath, DefaultLevelTemplateName,
-                assetInfo, watchFolder);
+            m_rootInstance->m_containerEntity->AddComponent(aznew Prefab::EditorPrefabComponent());
+            HandleEntitiesAdded({ m_rootInstance->m_containerEntity.get() });
 
-            if (sourceInfoFound)
+            AzToolsFramework::Prefab::PrefabDom dom;
+            bool success = AzToolsFramework::Prefab::PrefabDomUtils::StoreInstanceInPrefabDom(*m_rootInstance, dom);
+            if (!success)
             {
-                AZStd::string fullPath;
-                AZ::StringFunc::Path::Join(watchFolder.c_str(), assetInfo.m_relativePath.c_str(), fullPath);
-
-                // Get the default prefab and copy the Dom over to the new template being saved
-                Prefab::TemplateId defaultId = m_loaderInterface->LoadTemplateFromFile(fullPath.c_str());
-                Prefab::PrefabDom& dom = m_prefabSystemComponent->FindTemplateDom(defaultId);
-
-                Prefab::PrefabDom levelDefaultDom;
-                levelDefaultDom.CopyFrom(dom, levelDefaultDom.GetAllocator());
-
-                Prefab::PrefabDomPath sourcePath("/Source");
-                sourcePath.Set(levelDefaultDom, relativePath.c_str());
-
-                templateId = m_prefabSystemComponent->AddTemplate(relativePath, std::move(levelDefaultDom));
-                newLevelFromTemplate = true;
-            }
-            else
-            {
-                // Create an empty level since we couldn't find the default template
-                m_rootInstance->m_containerEntity->AddComponent(aznew Prefab::EditorPrefabComponent());
-                HandleEntitiesAdded({ m_rootInstance->m_containerEntity.get() });
-
-                AzToolsFramework::Prefab::PrefabDom dom;
-                bool success = AzToolsFramework::Prefab::PrefabDomUtils::StoreInstanceInPrefabDom(*m_rootInstance, dom);
-                if (!success)
-                {
-                    AZ_Error("Prefab", false, "Failed to convert current root instance into a DOM when saving file '%.*s'", AZ_STRING_ARG(filename));
-                    return false;
-                }
-                templateId = m_prefabSystemComponent->AddTemplate(relativePath, std::move(dom));
+                AZ_Error("Prefab", false, "Failed to convert current root instance into a DOM when saving file '%.*s'", AZ_STRING_ARG(filename));
+                return false;
             }
+            templateId = m_prefabSystemComponent->AddTemplate(relativePath, AZStd::move(dom));
 
             if (templateId == AzToolsFramework::Prefab::InvalidTemplateId)
             {
@@ -286,13 +255,6 @@ namespace AzToolsFramework
             m_prefabSystemComponent->RemoveTemplate(prevTemplateId);
         }
 
-        // If we have a new level from a template, we need to make sure to propagate the changes here otherwise
-        // the entities from the new template won't show up
-        if (newLevelFromTemplate)
-        {
-            m_prefabSystemComponent->PropagateTemplateChanges(templateId);
-        }
-
         AZStd::string out;
         if (m_loaderInterface->SaveTemplateToString(m_rootInstance->GetTemplateId(), out))
         {
@@ -303,6 +265,71 @@ namespace AzToolsFramework
         return false;
     }
 
+    void PrefabEditorEntityOwnershipService::CreateNewLevelPrefab(AZStd::string_view filename)
+    {
+        AZ::IO::Path relativePath = m_loaderInterface->GetRelativePathToProject(filename);
+        AzToolsFramework::Prefab::TemplateId templateId = m_prefabSystemComponent->GetTemplateIdFromFilePath(relativePath);
+
+        m_rootInstance->SetTemplateSourcePath(relativePath);
+
+        AZStd::string watchFolder;
+        AZ::Data::AssetInfo assetInfo;
+        bool sourceInfoFound = false;
+        AzToolsFramework::AssetSystemRequestBus::BroadcastResult(
+            sourceInfoFound, &AzToolsFramework::AssetSystemRequestBus::Events::GetSourceInfoBySourcePath, DefaultLevelTemplateName,
+            assetInfo, watchFolder);
+
+        if (sourceInfoFound)
+        {
+            AZStd::string fullPath;
+            AZ::StringFunc::Path::Join(watchFolder.c_str(), assetInfo.m_relativePath.c_str(), fullPath);
+
+            // Get the default prefab and copy the Dom over to the new template being saved
+            Prefab::TemplateId defaultId = m_loaderInterface->LoadTemplateFromFile(fullPath.c_str());
+            Prefab::PrefabDom& dom = m_prefabSystemComponent->FindTemplateDom(defaultId);
+
+            Prefab::PrefabDom levelDefaultDom;
+            levelDefaultDom.CopyFrom(dom, levelDefaultDom.GetAllocator());
+
+            Prefab::PrefabDomPath sourcePath("/Source");
+            sourcePath.Set(levelDefaultDom, assetInfo.m_relativePath.c_str());
+
+            templateId = m_prefabSystemComponent->AddTemplate(relativePath, AZStd::move(levelDefaultDom));
+        }
+        else
+        {
+            m_rootInstance->m_containerEntity->AddComponent(aznew Prefab::EditorPrefabComponent());
+            HandleEntitiesAdded({ m_rootInstance->m_containerEntity.get() });
+
+            AzToolsFramework::Prefab::PrefabDom dom;
+            bool success = AzToolsFramework::Prefab::PrefabDomUtils::StoreInstanceInPrefabDom(*m_rootInstance, dom);
+            if (!success)
+            {
+                AZ_Error(
+                    "Prefab", false, "Failed to convert current root instance into a DOM when saving file '%.*s'", AZ_STRING_ARG(filename));
+                return;
+            }
+            templateId = m_prefabSystemComponent->AddTemplate(relativePath, std::move(dom));
+        }
+
+        if (templateId == AzToolsFramework::Prefab::InvalidTemplateId)
+        {
+            AZ_Error("Prefab", false, "Couldn't create new template id '%i' when creating new level '%.*s'", templateId, AZ_STRING_ARG(filename));
+            return;
+        }
+
+        Prefab::TemplateId prevTemplateId = m_rootInstance->GetTemplateId();
+        m_rootInstance->SetTemplateId(templateId);
+
+        if (prevTemplateId != Prefab::InvalidTemplateId && templateId != prevTemplateId)
+        {
+            // Make sure we only have one level template loaded at a time
+            m_prefabSystemComponent->RemoveTemplate(prevTemplateId);
+        }
+
+        m_prefabSystemComponent->PropagateTemplateChanges(templateId);
+    }
+
     Prefab::InstanceOptionalReference PrefabEditorEntityOwnershipService::CreatePrefab(
         const AZStd::vector<AZ::Entity*>& entities, AZStd::vector<AZStd::unique_ptr<Prefab::Instance>>&& nestedPrefabInstances,
         AZ::IO::PathView filePath, Prefab::InstanceOptionalReference instanceToParentUnder)
diff --git a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.h b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.h
index 606d5f495f..915cafd316 100644
--- a/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.h
+++ b/Code/Framework/AzToolsFramework/AzToolsFramework/Entity/PrefabEditorEntityOwnershipService.h
@@ -170,6 +170,8 @@ namespace AzToolsFramework
         void StartPlayInEditor() override;
         void StopPlayInEditor() override;
 
+        void CreateNewLevelPrefab(AZStd::string_view filename) override;
+
     protected:
 
         AZ::SliceComponent::SliceInstanceAddress GetOwningSlice() override;
diff --git a/Code/Sandbox/Editor/CryEdit.cpp b/Code/Sandbox/Editor/CryEdit.cpp
index 0bbc48d5f9..5fd6eb2692 100644
--- a/Code/Sandbox/Editor/CryEdit.cpp
+++ b/Code/Sandbox/Editor/CryEdit.cpp
@@ -69,6 +69,7 @@ AZ_POP_DISABLE_WARNING
 #include <AzToolsFramework/API/EditorPythonConsoleBus.h>
 #include <AzToolsFramework/API/EditorPythonRunnerRequestsBus.h>
 #include <AzToolsFramework/API/ToolsApplicationAPI.h>
+#include <AzToolsFramework/Entity/PrefabEditorEntityOwnershipInterface.h>
 #include <AzToolsFramework/PythonTerminal/ScriptHelpDialog.h>
 
 // AzQtComponents
@@ -3105,6 +3106,15 @@ CCryEditApp::ECreateLevelResult CCryEditApp::CreateLevel(const QString& levelNam
     GetIEditor()->GetDocument()->SetPathName(fullyQualifiedLevelName);
     GetIEditor()->GetGameEngine()->SetLevelPath(levelPath);
 
+    if (usePrefabSystemForLevels)
+    {
+        auto* service = AZ::Interface<AzToolsFramework::PrefabEditorEntityOwnershipInterface>::Get();
+        if (service)
+        {
+            service->CreateNewLevelPrefab((const char*)fullyQualifiedLevelName.toUtf8());
+        }
+    }
+
     if (GetIEditor()->GetDocument()->Save())
     {
         if (!usePrefabSystemForLevels)