Around 40 riot squad officers stormed a Surry Hills terrace house at 4pm local time before raiding properties in Lakemba, Punchbowl and Wiley Park.
An “explosive device” was discovered at the Surry Hills property and deactivated by a bomb squad, according to The Seven Network.
Shouting and screaming could be heard as a man with a towel draped over his head was led away from the Surry Hills home by police.
The man was heard saying “they bashed me”. When asked by who, he answered “police”.
He was then asked why he was arrested, to which he mumbled “I don’t know nothing”.
Residents in the area were evacuated while the bomb squad worked to remove the “explosive device”.
Neighbour Kate Harrison said she heard a man yelling and pleading for someone to call police, before police stormed the house.
She told The Daily Telegraph: “There must have been at least 40 riot squad police with huge guns jump out.”
Another neighbour, whose property back onto the raided home, described the family living their as “perfectly nice and normal people”.
The woman in her early 30s, who did not want to be identified, told the AAP: “We knew them to say hello to and they seemed nice”
She said an elderly couple lived in the home, and they had adult children.
Australia has been on heightened alert for terrorist attacks by home-grown militants returning form the Middle East since 2014.
Around 100 people have left the country to fight alongside organisations such as ISIS in Syria, Australia’s Immigration Minister said last month.
Prime Minister Malcolm Turnbull has told the public not to panic.
He said: “My number one priority, and that of my government, is the safety and security of all Australians, and the public should be reassured that our security and intelligence agencies are working tirelessly to keep us safe.”
The operation was carried out by Australian Federal Police (AFP), NSW Police and the domestic spy agent ASIO and forms part of an ongoing investigation into an “aviation threat”.
AFP said: “Four men have been taken into custody and are assisting police with their enquiries.”
Mr Turnbull said: “These operations are designed to disrupt and prevent plans to undertake terrorist attacks in Australia.”