The Glebe area has recorded a 23 per cent increase in residents forced to take refuge in cars or on the streets.
Tenants of public housing apartments at 82 Wentworth Park Road in the suburb will be temporarily moved out while it is demolished and rebuilt from 17 units into 43 one- and two-bedroom apartments.
NSW Minister for Housing and Homelessness Rose Jackson said on Saturday the government needed to work quickly to address the dire state of social housing in inner Sydney.
"We want to rebuild our housing system to prioritise the people of NSW," she said.
"The restoration of these properties in Glebe reflects our unwavering commitment to providing quality homes for vulnerable people right across Sydney, including in our inner city."
Ms Jackson said the redevelopment would be 100 per cent public housing and overseen by a new entity dubbed Homes NSW.
"We know there is more to be done and every opportunity we have to deliver more homes for the growing housing wait list, we will take it," she said.
Another site, the Franklyn Street Estate, also in Glebe, will not be redeveloped as previously planned but another 35 vacant properties in the area have been purchased by the government and earmarked for social housing.
The former coalition government sold off almost 5000 public houses, prompting Labor to freeze the policy once it came to power.
The announcement of the Glebe initiative was welcomed by those working on the front lines of the city's housing crisis, with Homelessness NSW CEO Trina Jones saying the situation has never been worse.
"Right now the waiting list for social housing is more than 10 years," she said.
"For the growing number of people sleeping in cars and tents, and women living with violent partners, that is an impossibly long time," she said.
Ms Jones said the government needed to commit 10 per cent of housing in the state to social housing over the long term.
She is agitating for even more investment in public housing, with another 80 years needed to meet the waiting list based on current build times.
The head of Shelter NSW said the decision in Glebe couldn't come soon enough.
John Engeler said retaining the Franklyn Estate and involving residents in the redesign of Wentworth Park Road showed a "new level of co-design and meaningful engagement".
"The new homes can be built quickly and made available to previous tenants as well as many more new ones," he said.
About 100 people including Jenny Leong, the Greens Member for Newtown, rallied in Sydney's CBD on Saturday to call for a statewide rental freeze and an end to no-grounds evictions.
The Housing for People Not Profit protest was organised by Action for Public Housing to call for more public housing to be built and equitably distributed.
The group wants an end to the privatising of public housing, saying the federal government's Housing Australia Future Fund will barely scratch the surface.
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