Am I in the wrong hotel or location in Madrid

No such thing as "over reacting", but should you have concerns? No, I don't think so. This is the very centre of Madrid, so like any big city you will find street life, not only busy, but also quite colourful. Take the usual precautions with your personal safety and valuables. Being always busy and alive, I think this kind of location is 'safer' than somewhere on a dark deserted back street. Everything is within walking distance, so embrace it. Head across Gran Via to Horteleza and Fuencarral and on to Chueca - this is the gay Madrid of Pedro Almodovar, great for people watching, and great for shopping nowadays. As a personal side note ... In the summer of 1989 I spent time with friends just off P del Sol and walked Calle de Montera all the time, often late at night, usually drunk. Ah, memories. Ah, good times.

I stayed near there in 2007 and walked Calle de Montera and other streets in the area at night without any problems. I saw a number of prostitutes, and a lot of other people, tourists and locals, walking along; a lot of nightlife. A few prostitutes called out to me when I was walking alone, but were not aggressive. None talked to me when I was with other people, and I did not see any of them bother couples or groups. If you had children with you, the children might have questions, but the prostitutes won't bother you.
Just enjoy the city! I have always enjoyed Madrid.

Thank you for your comments. I feel better and I am going to look up the places in Madrid where Pedro Almodovar filmed. I love his movies!

Take a walk down that street on Google maps (drag the little yellow man in the bottom right of the map to the street). In the night it might be different, but during the day the street was unremarkable. At the other end of Calle de Montera, at Calle Gran Via, there is a McDonalds. One afternoon, I saw several women who appeared to be prostitutes not far from the McDonalds, but they didn't seem to be bothering anyone. I felt much more uncomfortable in Puerta del Sol.

There is always a re-assuring police presence on Puerta del Sol.

I stayed with my boyfriend in a hotel in that street a few years ago, near the MC Donald's and loved it there!! Yes, there is a prostitution area, but very safe and I didn't feel uncomfortable at any time. There was always a police car parked there, and if anything, the street was very lively and fun, and you can't beat the location for going out to see the city!

Correct, there are prostitutes along that street, but they don’t seem to actively solicit. Mostly they’re just standing around. You’ll know who is who when you walk around since they are easy to spot. That street is very well travelled by others and should pose no problem. As others have said, it’s centrally located between the Puerta del Sol and the Gran Via. Enjoy your trip.

Diane, you will be surprised (or not!) to notice that "street prostitution" in Madrid (or many other European cities for that matter) has little to do with the TV images of the sleazy 70s in say NY. While it's visible, it's rather passive (mostly) and does not interfere with other passer-byers. Moreover, this is not a secluded area, on the contrary, it's the middle of Madrid so there are literally hundreds of thousands of passer-byers in Montera and the surrounding streets. So, providing you don't have any personal prejudices, you shouldn't have any problem.