The Property Council says the Government's solution to boost cheap houses for first-home buyers would push up the prices of other houses as developers try to offset cuts in their profits.
Housing Minister Maryan Street introduced the bill, which would allow councils to require developers to include cheap housing in a project, or pay money or land to the council for use on affordable housing elsewhere.
The Affordable Housing: Enabling Territorial Authorities Bill is aimed at areas where first-time home buyers were struggling, such as Auckland and Queenstown.
It was estimated to result in about 1000 cheaper homes a year, which could be bought by or allocated to only first-time buyers on low to moderate incomes.
Any house designated an affordable home under a plan must also remain "affordable", with measures taken to ensure it was on-sold either to others on low incomes or the council.
Connal Townsend, the chief executive of the Property Council, said it meant other homebuyers would pay the price as developers put up the cost of mid- and upper-range homes to compensate for profits lost in developing the cheaper homes for first-time buyers.
"If a developer was doing 12 houses and one had to be sold cheap, the developer will take a cut in profit. They will recoup that by increasing the price of the other houses so most houses will go up in price, and that is perverse."
The bill provides for "incentives" to partially offset the cost to developers, which could include a waiver of development contributions, a rates rebate, or allowing more houses to be built on a property than would otherwise be permitted.
Mr Townsend said the incentives were a good idea, but the bill did not address the main reason for the housing shortage in Auckland, which was the price and supply of land for housing.
Auckland Mayor John Banks said he had not yet been briefed on the bill but although the council supported affordable housing, it was not a core job of the council to provide or subsidise it.
"We are not in the business of taking instructions from the Government."
Councillor Cathy Casey welcomed it, saying it was what the old city council had asked for and fitted well with the pilot shared-equity scheme run by Auckland City and the non-profit NZ Housing Foundation.
Although Mr Banks had wanted the scheme ditched, Ms Casey said it was under contract signed before Mr Banks' election and would continue.
Manukau Mayor Len Brown also welcomed the bill, saying up to 4000 new houses were built in Manukau every year and it would help ensure they catered for a wide range of people.
But he was concerned councils would have to bear the costs of it, including making an initial assessment of housing needs, followed by public consultation and development of a plan, the costs of negotiation and "financial incentives" for developers, and monitoring and reviewing the policy.
Ms Street said although many homes were built every year, very few were designed for first-time buyers or those on modest incomes. Home ownership was part of the national identity.
"The Government has a responsibility to do what it can to maintain this tradition and to ensure an evenness of opportunity between generations."
National housing spokesman Phil Heatley said housing affordability was a priority for National, but the bill did not solve the major problems of land supply, high mortgage interest rates, and compliance costs driving up building prices.
"National is yet to decide whether to support the bill, but I'm convinced desperate young house hunters will be disappointed."
Allows local councils in areas where there is a shortage of cheap housing to form an affordable housing plan, after public consultation.
Homes built under an affordable housing plan can be sold or allocated only to people who meet certain criteria.
These include earning a low to moderate income, owning no other properties, and being able to afford the housing costs as well as basic living costs.