Two men arrested as part of a counter-terrorism operation were planning to attack either a Sydney police station, or officers on the street, police believe.

Iraqi-born Omar Al'Kutobi and Kuwaiti national Mohammad Kiad have been charged with plotting to carry out a terrorist act.

Yesterday, heavily armed counter-terrorism police raided the Fairfield granny flat the pair share and seized a machete, a knife, a flag “representing” the terror group ISIL, and a video which showed a man allegedly talking about carrying an attack, from the granny flat behind a Fairfield property.

Mohammad Kiad (left) and Omar al-Kutabi. (Supplied)

Facebook photos of Mohammed Kiad. (Facebook)

The pair were refused bail today in Fairfield Local Court and refused to even leave the cells.

Tomorrow when they reappear in Sydney Central Local Court, police are expected to allege the two men planned on attacking a Sydney police station or even a police officer on the street at midnight last night.

Instead, dozens of counter-terrorism police swooped on their Fairfield granny flat yesterday afternoon.

They made the arrest under the belief an attack was imminent, and it was described as the closest we've been to an attack of this sort.

The pair had been renting out the converted garage, located behind a large share house, for several years for about $200 a week.

Inside, police found clothing piled high on top of furniture and lounge chairs, text books scattered across the floor and boxes of electrical items and cords.

An Islamic prayer flag and Islamic posters were also discovered inside the house.

Neighbours have described the pair as quiet, saying they kept to themselves and didn’t mix with others.

"They don't mingle much," Manuel Abello said.

"I never expected this at all. They are quite nice. Very rarely they have guests."

The pair rented out a converted garage behind this house in Fairfield house. (9NEWS) (9NEWS)

Mr Kiad's car is still parked out the front of the Fairfield property, with finger printing dust the only tell-tale signs of the police search.

Another neighbour witnessed yesterday's raid and said he was shocked to hear commotion coming from the pair’s bungalow about 4pm.

“I was watching a movie and then suddenly the electricity turned off ... so I went outside,” Roberto Macatangay told 9NEWS.

“They (police) pointed a machine gun at me.”

He said he saw both of his neighbours lying face down and cuffed and estimated “about 60” police officers were at the scene before he was ushered back inside his home.

But Mr Macatangay who has lived in the area for about three years said he believed Mr Al'Kutobi had been studying computer science and mostly kept to himself.

He said Mr Kiad split from his wife last year and moved from Auburn to live with Mr Al-Kutobi.

Deputy Commissioner Catherine Burn admitted authorities did not know anything about the men, aged 24 and 25, until hours before the arrests were carried out by the joint NSW Police Force and Australia Federal Police Operation CASTRUM.

"These men were not on our radar," she told reporters today.

"The type of act that we will allege was going to take place is consistent with IS messages," she said, referring to another acronym used to describe the militants.

The court heard one of the accused men intended to apply for bail.

Ms Burn said police acted quickly to stem what they believed would have been a violent attack on Australian soil.

"We received information that an attack was imminent and we acted," she said.

Asked if the men were planning a beheading, she said: "We don't really know what act they were going to commit".

"It was likely to involve one of the items which we seized which was a knife and it was going to involve a person."

ISIL has in the past urged homegrown extremists to carry out attacks on Western police and other authority figures.

The group has also become notorious for its filmed beheadings of hostages.

Ms Burn said the men posed no further threat to the community, but emphasised the need for the public to come forward with any information.

"The concerning thing is that it represents the nature of the environment we currently face," she said.

"We are ready, willing and more than able to respond to disrupt the plans of those who think they can engage in what can only be described as hideous offences so strongly opposed by the community."

Ms Burn said police were trying to determine if the men were in contact with anyone from ISIL.

"We are conducting further investigations. Yesterday, our focus was to act on information that we received about something that was imminent," she said.

"We believe that we have stopped that threat from occurring. However, there are further investigations that now we will need to follow through."

NSW Premier Mike Baird said he was proud of the work carried out by NSW and Federal police, but urged residents to not become complacent.

“I have ever confidence in our forces – they acted decisively and effectively and it was a first class job,” he told reporters in Sydney today.

“But (the arrests) are very concerning and shows this is an ongoing battle, an ongoing fight… we cannot afford to become complacent.”

He urged anyone who witnessed anything suspicious to report it to police.