The Burns Lodge at Holy Cross Centre advertises itself as a venue capable of hosting up to 120 paying guests, as well as weddings, conferences and other events.
The lodge, owned by the Catholic Diocese of Dunedin, has drawn largely positive reviews from guests.
One online site categorised it as a 2.5-star hotel.
The Otago Daily Times yesterday confirmed the lodge did not hold a consent for commercial residential use.
The site was zoned for religious, community and residential uses, not a commercial operation, Dunedin City Council rates information showed.
The situation came to light following an anonymous complaint to the Otago Daily Times, received yesterday, which alleged the lodge was running an ''illegal operation''.
Council senior planner Phil Marshall said the lodge had some existing use rights, dating back decades, but the new activity ''goes beyond existing use rights''.
''There is a potential issue there,'' he said.
Otago Motel Association president Sue Rhodes said the lodge enjoyed an ''unfair'' advantage over the association's members.
Moteliers had to meet higher regulatory requirements, including paying commercial rates and other costs, and set tariffs that reflected those extra costs.
''These guys [the lodge] just aren't doing it. They're popping up under the noses of the council and it's wrong. It's unfair.''
Lodge business manager Clinton Chambers ''completely'' denied any suggestion the lodge was operating illegally.
The lodge did not have a consent for commercial residential use, despite having ''fully gone commercial'' this year, but church representatives had been ''completely transparent'' with the council, Mr Chambers said.
They had first approached the council in 2015 to discuss plans to ramp up the lodge's accommodation operation, he said.
Since then, it had been decided to seek to have the church's land rezoned, to allow for a larger commercial operation, as part of the council's second-generation district plan (2GP) process, he said.
Mr Marshall, who met the group, said yesterday he did not recall any mention of the lodge during the meeting.
Instead, the focus had been on a proposed multipurpose function facility, before applying for a resource consent, he said.
Despite that, Mr Marshall ruled out enforcement action yesterday, saying he favoured the rezoning approach as the best solution.
A decision was not expected until the end of the year, and Mr Chambers said the lodge continued to rely on existing use rights in the meantime.
The church had occupied the site for 120 years, and had offered some public accommodation for the past 20 years, he said.
''It's only been in the last year and a-half that we've increased that activity.''
He dismissed concerns the commercial sector was being undercut, saying the lodge catered largely for school, religious and other community groups and was not in competition with other operators.
But it had hosted Lions rugby fans this week, he confirmed, and the lodge's website touted its ''deluxe suites'' as offering ''quality accommodation at hotel standard''.
Mr Chambers insisted that was important in a city facing an accommodation squeeze.
''We have to provide accommodation to meet the needs of accommodation in Dunedin, which everybody knows there is a great shortage of.''
Mr Marshall confirmed he had contacted Mr Chambers again earlier this month, after also fielding an anonymous complaint, and learned of the lodge's rezoning submission then.
Council resource consents manager Alan Worthington said if the rezoning bid failed, a resource consent process would be ''the likely outcome''.
The Catholic Diocese of Dunedin did not respond to a request for comment yesterday.
