Housing New Zealand and Wellington City Council are proposing a partnership agreement for a housing complex of 230-300 houses in the city's Mt Cook.
It is set to have 40 supported-living units for homeless people.
The partnership would take over the long-term lease of Arlington complex, with Wellington mayor Justin Lester saying the proposal would make a "significant difference" for housing in Wellington.
"The new Arlington development will be a high-quality mix of public and affordable housing, be close to the city centre and help address a shortage of accommodation for people on housing waiting lists and homeless people," he said.
"There are about 60 people living rough in central Wellington, 386 people on the Ministry of Social Development's waiting list and 72 in transitional housing seeking permanent homes. A development of this scale will go a long way to addressing our housing needs."
The current state of Arlington Complex is "tired, dilapidated and unfit for purpose", Wellington City Council said in a statement.
Housing Minister Phil Twyford said the proposal was a "rare opportunity" for public housing development in central Wellington.
"These will be high-quality homes with onsite treatment for those who need it the most."