City Hostel Berlin reportedly pays £32,000 a month in rent to the secretive state which also raises funds with a conference hall on the site.
UN sanctions on North Korea are aimed at shutting down its revenue streams to slow the pace of its testing of nuclear weapons.
Foreign secretary Markus Ederer said: “We must increase pressure to bring North Korea back to the negotiating table.
“In that regard, it is particularly important that we do even more to dry up the financial resources used to fund the nuclear programme.
“The German government is in complete agreement and the responsible authorities will now take the necessary steps.”
The hostel’s bargain nightly rate of just £8 has made it a magnet for backpackers travelling to the German capital on a budget.
The UN banned leasing arrangements by North Korean embassies worldwide as part of Security Council Resolution 2321, passed in November 2016 after Pyongyang’s fifth nuclear test.
The resolution says: “All member countries shall prohibit North Korea to use real estate that it owns or leases for other than diplomatic or consular activities.”
Pyongyang officials apparently leased the property to two operators in 2004 and have raked in tens of thousands of euros in rent each month.
North Korean embassies have played an important role worldwide to undermine the financial sanctions that have been imposed for years.
Experts say the foreign exchange generated through the businesses is used to buy luxury goods and secure the operation of the embassies but also reportedly finances crackpot leader Kim Jong-un’s ambitious rocket and nuclear programme.
The North Korean representation in Berlin has been a problem for governmental circles for years, according to reports.
The agency has been under observation for years because it plays a role in the attempted procurement of sensitive goods for the North Korean weapons programme.
North Korea’s UK embassy is based in a detached house on the busy North Circular Road near Ealing, west London.