A huge pall of smoke could be seen across the town.
Robyn Mulligan, who has owned the hotel for about 11 years, and Lindsay McDougall, her bar manager of four years, lived in rooms upstairs.
Mr McDougall said Ms Mulligan was unable to stay at the scene and was being comforted by a friend at a nearby house.
He said he had lost his possessions, but was pleased there had been no injuries.
"No-one's hurt, and that the main thing."
Staff member Sheryl Tamati said the fire broke out about 4.30pm.
Dozens of firefighters were called to the scene until eventually there were five appliances, one with a long ladder attached, and a water tanker.
Police and St John also attended.
Onlookers said smoke billowed from the building for about half an hour before flames broke through the roof soon after 5pm.
About 5.30pm, a firefighter said the upper floor had collapsed inside the building and firefighters were unable to get inside.
Watching from the other side of the road, Loel Kennedy said the hotel was "gone".
"She wouldn't be worth saving now."
Her parents owned the tavern in the 1950s and she lived there, worked there and was married there.
"It was a lovely building. It's a jolly shame to see it go."
Resident Robbie Wallace said he was also sad to see the tavern ablaze.
"It's a huge icon gone."
