The UN has asked Israel to freeze all pending demolition orders in East Jerusalem and to do more to provide for the housing needs of Palestinians.
Almost a third of all Palestinian homes in East Jerusalem have been built without a permit, says a UN report.
This puts 60,000 Palestinians at risk of having their houses demolished by Israeli authorities.
The mayor of Jerusalem, Nir Barkat, has acknowledged a planning crisis for all of Jerusalem.
The report, produced by the UN's Office for the Coordination of Humanitarian Affairs, says the root of the problem in a lack of adequate urban planning by the Jerusalem municipality which controls East Jerusalem.
Palestinians wanting to build a home can only seek permission to do so in a small area. It comprises about 13% of East Jerusalem and is already densely populated.
As a result at least 28% of all homes have been constructed illegally.
Out of the quarter of a million Palestinians living in East Jerusalem, the UN says, 60,000 are at risk of having their homes demolished by the Israeli authorities.
Israeli officials reacted to the UN report by saying that building codes are enforced even-handedly across the city.
Jerusalem's municipality has said all Jerusalem residents are treated equally whether built to house Jewish or Palestinian families it says, all illegal buildings must be pulled down.
The office of the mayor of Jerusalem, Mayor Nir Barkat, disputed the figures given in the UN report.
But Mr Barkat admitted that there was a planning crisis in all of Jerusalem that "affects Jews, Christians and Muslims alike".
A spokesman said, a master plan for the city would be announced in the coming weeks.
The UN report says that approximately 1,500 demolition orders have been issued and are pending. If carried out they would make 9000 people homeless, half of them children.
Overall the UN estimates a gap of about 1,100 housing units per year in the Palestinian community in east Jerusalem.
Those who build illegally not only risk losing their home, but also "face heavy fines imposed by the Jerusalem municipality and, in some cases prison sentences".
Hardest hit are the children, says the report.
"In the immediate aftermath of demolitions, children often face gaps in education and limited access to basic services such as health care and clean water. Longer-term impacts include symptoms of psychological distress."
Israel has occupied East Jerusalem since 1967. It has annexed the city and declared its east and west Israel's eternal capital.
This is not recognised by the international community, with the east of the city considered occupied territory.
Palestinians hope to establish their capital in East Jerusalem. They say Israel uses demolition orders to try to force them out of their homes.
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