The Government will spend $377 million to add more bedrooms to existing state houses and to build extra houses.
Housing Minister Nick Smith said "Project 324&5" was designed to convert three-bedroom houses into four- and five-bedroom homes.
"Project 324&5 recognises that Housing New Zealand, and particularly Auckland, have an oversupply of three bedroom homes and a real shortage of larger ones," Dr Smith said.
"The initiative is expected to deliver up to 3000 new state house bedrooms to 2000 properties over the next two years, with three quarters of them in Auckland.
"Adding an extra one or two bedrooms to these properties will better meet tenants' needs in relation to size, location and amenity. It will also result in less overcrowding and better health and education outcomes."
Properties targeted for modification would be houses up to 40 years old and on medium to large sections able to accommodate extensions and still have enough land to provide a decent outdoor area for tenants and their families.
Some of the three-bedroom houses would be expanded to five-bedroom, two-bathroom homes where it could be accommodated on the site and where there was demand.
"I'm confident the modifications can be done quickly, efficiently and with minimal disruption to tenants. Housing New Zealand has designed and trialled modular units that are suitable to most locations and that can be attached to existing structures," Dr Smith said.
Another project is to build an additional 500 infill two-bedroom state houses over the next two years on large Housing New Zealand properties in Auckland.
"There is strong demand from Housing New Zealand tenants for more two bedroom homes in Auckland. This is a result of a shortage of supply and increasing demand for two bedroom properties, particularly for single people with caregivers, couples with children, and solo parents," Dr Smith said.
"The Simply Smart Homes infill project will see pre-fabricated modular homes, to minimise disruption to existing tenants, assembled on the sections of large Housing New Zealand properties in Waitakere, North Shore and Manukau."
Project 324&5 is expected to cost up to $260 million and Simply Smart Homes initiative $117 million.
The work will be completed by the 2015/16 year.
"These new initiatives are part of the Government's Accord with the Auckland Council to increase the supply and affordability of housing," Dr Smith said.
The 500 new infill houses will contribute towards the target 39,000 houses over three years announced in the Auckland Housing Accord.