The proposals for North Wales Hospital in Denbigh have been put forward by Prince's Regeneration Trust.
Denbighshire council won a compulsory purchase order earlier this year from the site's owners amid concerns about the Grade II-listed building.
Freemont (Denbigh) Ltd is expected to retain ownership until early 2017.
Subject to the change of ownership, Denbighshire council plans to hand over the former Victorian asylum to North Wales Buildings Preservation Trust.
It will operate as a not-for-profit organisation raising the money to preserve the listed buildings on the site via its "enabling development" plans, with profits made from the sale of new properties elsewhere on the site.
Freemont bought the hospital site in 2003 following its closure in 1996.
Planning permission was granted in 2006 for a redevelopment scheme but it has since expired and no work was carried out.
In 2015, the council spent Â£900,000 on emergency repairs in a bid to protect it from deterioration.
Freemont, which is based in the British Virgin Isles, had opposed the compulsory purchase, while Ayub Bhailok, speaking on the company's behalf, called the latest plans "flawed and unsustainable".
On Wednesday, Denbighshire council's planning committee approved the latest proposals.
Ward councillor Colin Hughes said the development would "be very good for the town", bringing an increase in residents and visitors.
"The importance of this development to the future of Denbigh is immeasurable," he said.
"Nothing has happened here apart from deterioration in the last 21 years," he added, referring to the building itself which, he said, had played a large part of people's lives in the past.
"As it is now it is absolutely useless to us."
Plans to partly demolish a derelict Denbighshire landmark, building up to 200 homes and 34 apartments, have been approved.