Overlays are basically floating sprites, or text. They are displayed above the background, but below GUIs.
You'd use them to create all kinds of graphic effects, like making the background blurry or something like that.
If you're worried about performance, make a test game that's going to strain AGS. Lots of rooms doesn't though since only one room is loaded into memory at any given time.
But like the others already pointed out, unless you're really pushing it, AGS should handle 1024 just fine.