Development of the Ministry of Defence-owned site has been the subject of a long running planning saga that has already seen one major application abandoned.
Homes England has now said it expects to submit plans for 500 homes, rather than 2,000 homes as had previously been proposed.
The agency said the decision was taken "following further careful consideration of the environmental sensitivities in and around the site".
However, Alan Jarrett, leader of Medway Council, said he was "extremely disappointed" at the announcement.
"Like other local authorities across England, we are under huge pressure from central government to quickly build thousands of new homes," he said.
"This decision will put greater pressure on already scarce land available in Hoo.
"We are committed to providing sustainable growth across Medway through the preparation of our local plan, but I now question if this decision demonstrates the government’s own commitment to meet their housing targets.
"We will now need even greater support from central government to help us provide the new homes expected in Medway."
The local authority granted planning permission for 5,000 homes, three primary schools, a secondary school, medical facilities and leisure and retail space back in 2014.
Permission was granted despite part of the land having been declared a site of special scientific interest (SSSI) the year before, due to the presence of nightingales.
The designation led a planning inspector to declare the Medway core strategy unsound back in 2013.
In February 2015, the planning application was called in by then planning minister Brandon Lewis after lobbying from campaign groups including the Royal Society for the Protection of Birds.
Developer Land Securities subsequently pulled out of the scheme in September that year and in September 2017 the application was withdrawn, prompting an angry reaction from Medway Council.
Homes England said it will consult with local residents in 2019 before submitting a formal planning application.
Ken Glendinning, head of strategic land at Homes England, said: "We remain committed to creating new homes at Lodge Hill in line with the government’s policy on use of surplus land, and we have always been aware of the sensitivities surrounding the important environmental elements of this development.
"After careful consideration, we believe that this approach will avoid any impact on the SSSI, while still making an appropriate contribution to Medway’s housing need for local people.
"We are grateful to all of our stakeholders and partners, including Natural England, for their support and advice to date."