Increasing housing density in Sydney's most affluent and sought-after suburbs will have the greatest effect on housing affordability, a new report says.
The state's relatively low rate of housing construction has failed to keep pace with demand, sending house prices and rents spiralling and resulting in a housing affordability crisis.
Building more housing in areas closest to the CBD is a recommendation that sits in contrast to the previous government's focus on new developments in western and southwestern Sydney.
NSW Productivity Commissioner Peter Achterstraat said the costs of enabling more housing in inner suburbs near existing jobs and infrastructure are "substantially lower" than elsewhere.
Mr Achterstraat detailed how changing current building regulations, such as increasing average heights and dual-occupancy dwellings, will allow for greater density in areas of highest demand.
The commission's latest report 'Building more homes where people want to live' suggests adjusting housing targets "to better match existing demand-supply imbalances" by building higher and more densely in the CBD and inner suburbs, including along public transport lines to leverage existing infrastructure.
"The major advantage of apartments is their ability to create more (and diverse) housing with the same locational benefits, without using additional land," the report said.
"Building up is especially efficient in inner suburbs because it lets us more easily locate our homes close to jobs and amenities, or close to transport hubs that can move people there more quickly."
The commissioner also suggested allowing more dual-occupancy uses such as granny flats where increased density is not an option.
Planning Minister Paul Scully welcomed the commission's suggestions, saying homes need to be built closer to jobs and services in order to drive down the cost of housing and make the best use of Sydney's assets.
"We cannot continue to add another street every other week to our urban fringe," he told AAP.
"We are supporting councils to recruit more planners, refocusing NSW government agencies on delivery and reforming infrastructure contributions to fund the infrastructure needed to support growing communities."
Without nominating areas for increased housing, Opposition Leader Mark Speakman said more density around train stations and other "appropriate locations" was needed as well as greenfield developments.
"What I won't do is engage in the kind of class warfare that the Labor Party wants to do - an east versus west warfare," he told reporters on Wednesday.
The report also found NSW builds fewer homes per capita compared to other states.
Since 1992, NSW has built six dwellings per 1000 residents on average. Victoria and Queensland have built around eight and nine per 1000 respectively.
The government's current forecasts estimate NSW will require approximately 900,000 additional dwellings by 2041 while available analysis suggests a 10 per cent increase in national supply will reduce the cost of housing by 25 per cent.
Reserve Bank governor Philip Lowe told a Senate estimates hearing on Wednesday that the best solution to the nation's housing and rental crisis is more housing supply.
"The solution to all these problems in the housing market is supply, supply, supply," he said.
