The Department of Justice has said it is "disappointing" that a bidder has withdrawn from the tender process to provide a Direct Provision centre in Oughterard, Co Galway.
Fewer than 250 asylum seekers would have been accommodated at the Connemara Gateway Hotel.
It said that the development "will ultimately exacerbate a very serious situation" regarding the shortage of accommodation for asylum seekers.
Justice Minister Charlie Flanagan said that comments made about direct provision services in Ireland are "grossly misleading" adding that the services have improved over recent years and are now in line with EU law.
"People have demanded we close down our accommodation centres," said Minister Flanagan.
"They have been less forthcoming with proposals as to where housing would be sourced for the 6,014 people availing of services in Centres and the 1,379 people being provided with shelter and services in emergency accommodation and the dozens of people who will present today, tomorrow and the next day seeking the protection of the State."
Locals in Oughterard say that they are willing to welcome asylum seekers to the town, but not under the terms of direct provision.
Edythe McAleer, who was opposed to the centre, says locals are prepared to open their doors to people waiting for a decision on their asylum application.
"We have vacant houses that we are willing to put families in, where they can be integrated," said Ms McAleer.
"I do know that these direct provision centres are wrong. It is inhumane putting five people into a room.
"It's like an open prison."
Minister of State with responsibility for Equality, Immigration and Integration, David Stanton said that positive stories about direct provision "are largely ignored and that is a great pity".
Mr Stanton said: "Centres were introduced to mitigate this and to provide supports and services.
No person is obliged to avail of these services which are entirely optional.
A spokesperson for the Department acknowledged that there is a need to engage with communities ahead of new centres opening.
They said that it is working on improving their community engagement structures.
"It was disconcerting to see a new trend emerging and to hear the owner say that that he had made his decision in the interests of the safety of all involved including his workers," the spokesperson said.
The Department will evaluate other bids received progress the remaining tenders in the Dublin and border regions.
"The Department acknowledges that the system of Direct Provision is not perfect but we are working to improve it.
"Without it we would not be able to support the thousands of people who arrive here with nothing every year to seek our protection."
"That is an obligation that it takes very seriously."