I've lived almost half a decade with a local before we married on mainland. We had few issues, but the only major one that stands out is that we were refused a hotel room once. I really don't believe it's illegal as my experiences suggest that locals were willing to rent us homes or hotel rooms when we were on vacations. Moreover, my experience that my previous employers allowed us to stay in their appartment also suggests there's nothing wrong with that. However, others may have different experiences and don't forget that China is changing fast. Changes that are directed at foreigners may as well be more inconvenient than convenient, since this country is gearing towards some sort of a new sophisticated "iron curtain" style.
Cheers and beers to our fine local companions we want to or have to live with