Byron Shire faces unique cost of living pressures amplified by being a year-round tourist destination, the NSW Independent Planning Commission found earlier this year.
The cost of housing in the region has risen significantly in recent years, with growth outpacing other parts of NSW and Sydney.
About 1300 or one in 12 homes in Byron Shire are being used as short-term rentals.
Many were previously let long-term.
In a bid to encourage homes to be returned to long-term residency, the NSW government has endorsed a two-month cap on some non-hosted short-term accommodation.
Byron Shire Council proposed halving its 180-day cap on short-term rentals last year but the commission's advice went further and said a 90-day limit would not incentivise landlords to return properties to the market.
The cap will be tightened to 60 days, although some precincts near beaches and services will be able to operate without a cap.
Planning Minister Paul Scully said the decision would help key workers and permanent residents who were increasingly being priced out.
"Given the region's unique and exceptional circumstances as one of Australia's most visited tourism destinations, it is crucial housing supply shortages are addressed and more homes are returned for permanent residency, particularly to have workers in the visitor economy," he said.
But he said reinstating rentals for long-term residents was only one step in addressing housing supply and affordability issues.
Byron Shire mayor Michael Lyon said it was about striking a balance between accommodating visitors and ensuring housing was affordable for permanent residents.
"Slight increases in the cost for the visitor are really not as important as ensuring that locals have actually got somewhere to live and the rest of the economy that needs the workers, that relies on having workers that can live close by, benefits," he told ABC radio.
Mr Scully stopped short of adopting all of the commission's recommendations, saying they would have broader implications for short-term rentals across the state.
They included a levy on short-term stays and making the 60-day cap apply council-wide without exemptions for peak tourist zones.
The planning department will instead take these recommendations into account as part of a broader review later this year.
A 12-month transition will apply before the new rules take effect in September 2024.
Non-hosted short-term rentals are restricted to a maximum of 180 days a year in Greater Sydney and self-nominated local government areas including Ballina, Byron, parts of Clarence Valley and parts of Muswellbrook.
The Greens have called for national regulation on providers such as Airbnb to take pressure off rents but federal Housing Minister Julie Collins says those rules are a matter for the states.
The Victorian government announced last week a 7.5 per cent levy on platforms such as Airbnb and Stayz from 2025 in Australia's first blanket tax on short-stay accommodation.
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