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Not if it's designed to let the Cat-1s live a facsimile of normal life but with the support system they lack on the outside. AIUI, the primary problem Cat-1s experience is a loop of helplessness: without a home, they can't find work; without work they can't find a home. You need a city-like environment in which they can operate freely with support long enough to get back on their feet and/or develop work skills if they lack them. They would not be incarcerated like or with the more dysfunctional levels. They would live amongst the professionals who operate the carcereal parts of the system.
Cat-1s aren't usually that badly off, mentally speaking. It's mostly folks who used to have jobs (and some still do), and could still hold down a job if they could find something appropriate. They can work, they can pay bills, they can pay rent, they can maintain a home, but they're low on social and economic capital and finally slipped through a crack. The current system works decently well for them, but it could always be made better, especially by increasing the availability of cheaper (crappier) housing.
Your categories use "psychotic", but there's a large range of potential mental problems that can cause (or result from) homelessness (or excessive drug use). And sometimes someone who looks like Cat-1 is actually suffering from some untreated mental problem that finally got too nasty for their coping mechanisms to deal with, causing them to lose their job and get kicked out of their home. Those are the ones that need special support like you suggest, but they're not really what you refer to as Cat-1, or are only superficially Cat-1.
Where I think a lot of other solutions fail is that they are only aimed at 1 type of homeless person and there is no coordination with the services that address the other types of homeless people. In my model, there is coordination so that misidentifications of type can be transferred to the appropriate wing within the all-encompassing system.
It also, importantly, removes all of the homeless individuals from mainstream society until they are fit to rejoin it. For the Cat-1s, it would be voluntary, but presumably if they are genuinely Cat-1 this is exactly the absent support that they are looking for.
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