The short term closure order came into effect at 7pm on Friday following a targeted operation by the police and Office of Liquor, Gaming and Racing over the past week.

Police raided the venue last Saturday night and charged two staff with drug offences after officers witnessed them taking ecstasy before continuing to sell alcohol to patrons.

"Bar staff were observed openly consuming illicit drugs while performing their duties," according to a statement from OLGR released Friday night.

Several patrons were also seen in possession and under the influence of illegal drugs, including supplying and consuming drugs in the toilets.

The OLGR have pointed the finger at the Hotel's new management, Spice Group International (SGI), who took over the iconic venue late April.

SGI's founder and DJ Murat Kilic and his team operated the Sydney nightclub Spice Cellar in Martin Place before relocating the dance club to Erskineville.

"The hotel has come under increasing attention by both OLGR and Police due to numerous drug detections, repeated intoxication issues, and ongoing disturbance issues from patrons leaving the venue in the mere two months since the hotel came under new management," the OLGR statement read.

The venue's operators have been repeatedly served official warnings by authorities concerning its lax drug control measures, the OLGR said.

Anthony Keon, OLGR director of Compliance and Enforcement said the venue had failed to implement appropriate controls to deal with illicit drug use and intoxication despite "numerous regulatory engagements".

"A situation where bar staff and patrons are openly consuming drugs at the venue, and where there have been repeated drug and intoxication issues, is completely unacceptable and shows that the venue has been operating with a complete disregard for its obligation and responsibilities," Mr Keon said.

"Without significant and material changes to the management and supervision of the venue the likelihood of further illegal activity occurring at the venue is extreme, and the only appropriate action is to close the venue," he said.

Newtown Local Area Commander Superintendent Simon Hardman said the Hotel's closure under the Liquor Act was a warning to business owners in the area.

"We will actively pursue any venue where illegal activity is thought to be taking place," he said.

Other issues identified by authorities at the hotel were public disturbances and anti-social behaviour by patrons including excessive noise, vandalism, public urination and defecation, and concerns over fire safety risks.

Patrons were seen falling asleep in the venue and one woman was found passed out in a toilet cubicle.

The Australian Hotels Association have hinted Sydney's lock out laws are to blame for nightclub operators creeping into residential communities to avoid the stringent regulations implemented in March 2014 by the O'Farrell government.

"Event/venue operators that relocate out of the CBD precinct into residential communities to avoid lockouts need to ensure the peace and good order of the neighbourhood is prioritised so that they operate within community expectations," said a spokesperson for AHA.

"This is an example of the regulators targeting an individual operation that has come under notice rather than imposing a blanket approach, which is to be applauded. There are strict controls around the granting of 72-hour closures so there is a need for the operator to have a serious look at their business model and make changes if they want to be part of the community," he said.

The hotel will remain closed until 7pm on Monday 22 June.

Mr Kilic was unavailable for comment.