“In particular, this move contradicts the logic of a reasonable and necessary agreement between the parties on the status of Jerusalem,” she said.

Secretary General Ban Ki-moon of the United Nations said that “inserting settlers into Palestinian neighborhoods in Jerusalem” undermined prospects for addressing the city’s status.

Israel annexed the eastern part of Jerusalem after capturing it from Jordan in the 1967 war and says it has sovereignty there. The Palestinians claim East Jerusalem as the capital of a future independent state.

The Shepherd Hotel is in the Sheik Jarrah neighborhood just north of the Old City, in an area that is coveted by both Arabs and Israelis. Although it is mostly populated by Palestinians, nationalist Jewish Israelis have moved into a number of houses there in recent years, evicting the Palestinian residents after Israeli courts ruled that the properties had belonged to Jews before the establishment of the state of Israel and the Jordanian takeover of East Jerusalem in 1948.

Mr. Luria, rejecting Palestinian arguments about the “Judaization” of Arab neighborhoods around the Old City, said he had no problem with Jews and Arabs living together in Sheik Jarrah. He noted that the area was close to the Israeli national police headquarters and several Israeli landmarks.

Members of the grand mufti’s family, the Husseinis, who remain prominent in Jerusalem, milled outside the compound. Among them was Adnan Husseini, the Palestinian Authority’s governor of Jerusalem.

“Everyone in Palestine is sad to see this,” he said.

A scuffle broke out when Palestinians approached Mr. Luria and asked to see a pamphlet he was holding on the grand mufti’s Nazi ties.

After the grand mufti was exiled by the British in 1937, the property became a British military outpost; it was rented to hoteliers during the Jordanians’ rule. The Israeli authorities confiscated the property in 1967, defining its owners as “absentees.” It was purchased by a corporation owned by the businessman Irving Moskovitz of Miami in 1985. In recent years, the hotel had fallen into disrepair.