Affordable housing for Aboriginal Elders in Redfern is set to be boosted following the approval of a multi-million dollar grant.

Under the Metropolitan Local Aboriginal Land Council's proposal, supported by $3 million via the City of Sydney, an existing commercial building on George Street will be demolished and replaced with new residences.

Once complete, the project will prioritise housing for Aboriginal Elders aged 55 and over who are able to live independently.

Metropolitan Local Aboriginal Land Council (LALC) CEO, Nathan Moran, welcomed the decision.

"We believe the project would provide many benefits. It's a long-standing dream to provide Elders accommodation in Redfern," Mr Moran said.

"There is strong demand from Aboriginal community members for affordable housing for Elders in the inner city, provided by an Aboriginal-controlled organisation.

"A lack of affordable housing can lead to negative impacts including Elders needing to leave their community, housing stress or living in sub-standard or overcrowded housing."

Early estimates suggest between six to 10 new homes will be built.

Aunty Ann Weldon, a respected Wiradjuri Elder, founding member and CEO of Metropolitan LALC who was part of establishing the Redfern and inner-city Aboriginal community, said: "We need this kind of accommodation for our mob."

"It means we can now stay close to family, country, and community as we grow older," Aunty Ann said.

The City of Sydney says its affordable and diverse housing fund supports all forms of subsidised housing which cater for the specialised housing needs of groups of people who may not be supported by mainstream housing options.

Lord Mayor of Sydney, Clover Moore, said while housing is the responsibility of the NSW Government, the City of Sydney is providing whatever assistance it can to help those who need it most.

"Providing affordable and diverse housing is a key focus for us. It is vital we increase the supply of affordable housing to ensure we continue to have an adaptable, diverse and inclusive city," Ms Moore said.

"Too often, Elders are forced to leave their communities in search of affordable housing. We are proud to back an Aboriginal-led housing solution that will allow Aboriginal people to age with dignity and independence in the heart of Redfern, keeps families and communities together."

The City of Sydney is also providing support for a new Aboriginal-operated aged care facility on Cope Street in Waterloo.

The $3 million housing grant will be staggered across three stages, with the first step being the Metropolitan Local Aboriginal Land Council preparing a development application for the building.