The formation of P2P logical networks oblivious to the structure of physical topology results in large amount of redundant network traffic. In addition to this mismatch problem, there exists a skew in properties of the participating peers which degrade the performance of P2P networks. So the current P2P systems call for effective overlay formation taking into consideration the underlying physical network topological properties and also inbuilt heterogeneity in participating peers. The heterogeneity of peers in the network can effectively used to bias neighbor selection and improve network performance by assigning more responsibility to nodes with higher capabilities. This paper presents two techniques to solve the problems of topology mismatch and heterogeneity. The proposed methods make use of bandwidth of peers and distance measures for overlay formation in the Gnutella network. The designed systems are tested with proper analysis and simulations to verify the correctness of the methods.