I always thought this could only be achieved by a fluke with Milkshapes terrain generator...but I think I may have found a better way to do it.
Go here and download the Terrain Generator. This terrain generator is awesome because you design the terrain with your mouse rather than relying on a random height map generator. Once you have created your terrain, texture it and export it to .OBJ. Open up Milkshape (or whatever program you use) import it then export it to Direct X format. When you run "MakeentitiesfromXfiles", I think 40 is the best scale for 16x16 maps, but it depends on the size of the terrain I guess.