Work is still under way on plans but it is intended to incorporate the existing building, not demolish it. It has not been confirmed how much the hostel will cost.
The Friendly Group owner Ron Lazarovits said they had been looking at options in Rotorua for some time and the site was by far the best they had come across.
"The Lakehouse site, with its incredible views over Lake Rotorua to Mokoia Island, its access to the geothermal resource, and proximity to the city make this site something that can be truly unique for our guests."
He said the Rotorua operation would complement his group's Australasian and American operations and provide "natural connectivity" in the quality backpacker market.
The Melbourne-based businessman said he had been watching the Rotorua tourism market develop over recent years and was keen to extend the Greenhouse offering into New Zealand.
Pukeroa Oruawhata Group trustee and director David Tapsell said the joint venture was the start of a new stage of the group's development.
He said the focus previously had been on getting the large-format retail developments completed and now they were substantially done, the group could change its focus to investing in tourism infrastructure to support the overall growth of the city.
He said the group had been working on the Greenhouse Rotorua concept with Mr Lazarovits for months and working with an industry leader with strong connections in the Australian, Asian and US markets was a great opportunity.
"Their skills, experience and connections into international market will be a huge asset as we establish this business."
Work is expected to begin on the redevelopment of the existing Lakehouse Hotel in the first quarter of next year.
Rotorua Mayor Steve Chadwick said the announcement was "wonderful news".
"It's another iwi-led investment, another development that continues the refreshing of our tourism offering and of our district.
"Spa-related holidays is a trendy market which is particularly sought out by people who enjoy being active and this new development fits really well with our spa tourism aspirations.
"The Lakehouse site is an iconic spot in Rotorua so it's a prime position with good links to Kuirau Park, the lakefront and the inner city.
"I think the ongoing growth of our tourism market - which has been out-performing the national average for most of the last year - shows there is demand."
Deputy Mayor Dave Donaldson said there was "a lot of positivity" within the local business and tourism sectors.
"There are some sizeable projects under way and planned which is something we haven't seen in Rotorua for some years and that gives me a lot of confidence about the district's economic future," he said.
"Along with new developments, there's been a lot of reinvestment by the tourism sector with operators upgrading and adding to their offerings and we're aware of further projects in the wind.
"It's all great for Rotorua and also suggests the prospect of more jobs.
"We're extremely well placed to benefit from the pressures faced by growth centres such as Auckland and Tauranga.
"Time will tell, but all of the activity we're now seeing gives me a lot of confidence."
