I had the same problem (on 16.04.02) and came up with a rather dirty, but quick and effective workaround.
Simply remove the libvirt-dnsmasq user's ability to read /etc/hosts:
sudo setfacl -m user:libvirt-dnsmasq:--- /etc/hosts
The libvirt dnsmasq instances will syslog a complaint when they start or get HUP'd. Otherwise, it seems to work perfectly.
I had the same problem (on 16.04.02) and came up with a rather dirty, but quick and effective workaround.
Simply remove the libvirt-dnsmasq user's ability to read /etc/hosts:
sudo setfacl -m user:libvirt- dnsmasq: --- /etc/hosts
The libvirt dnsmasq instances will syslog a complaint when they start or get HUP'd. Otherwise, it seems to work perfectly.