Haven't seen any lore on this, so i'll go.
I imagine the Entity sees the characters the same way we do.
It then browses through the cosmetics it made for them and poofs it onto them to see if it's good.
I guess the entity is like a little girl dressing up her dolls 🤔
Cosmetics are derived from memories for certain characters while other cosmetics are "found" in the fog, meaning that the Entity created them. Take Steve's Babysitter outfit versus Dwight's Vigo's Apprentice outfit. It's a sick and twisted monster but it does enjoy playing dress up.
We are the ENTITY!🎃
there is a little bit of lore
the auric cells: This ones conform the realms, so all the maps we play in and see are made of auric cells
The auric cells can be used to create, then somehow, someone could be able to use this cells to create clothing (at least this last part is what I think)
The Entity read the News with growing alarm, almost terror, which in itself was unusual for something as nightmarish as the Entity... but all the survivors were getting new outfits and the Entity only had enough auric cells for one outfit. But which one? The Entity's torment was almost palpable.
What about Dwights trapper T-shirt?
I don't think we really know the canonicity of the shop. It's implied that some outfits were from a survivors' past, some belonged to somebody else, and some were possibly found lying around in the Fog. It's implied that Auric Cells are used to create the outfits, whether it's the survivors harnessing them for one another or the Entity playing dress-up with its dollies, I really don't know.
What about shirtless David?
Maybe Entity looked at him when he was shirtless while switching tops and was like...
The Entity has a sick sense of humour too. Feng's facemask as well.