Canned outside hotel and diluted (7)
I believe the answer is:
thinned
'diluted' is the definition.
('thinned' can be similar in meaning to 'diluted')
'canned outside hotel' is the wordplay.
'canned' becomes 'tinned' ('tin' can be a synonym of 'can').
'outside' means one lot of letters goes inside another.
'hotel' becomes 'h' (phonetic alphabet: alpha, bravo, charlie etc.).
'tinned' going around 'h' is 'THINNED'.
'and' acts as a link.
(Other definitions for thinned that I've seen before include "Reduced" , "Made less thick" , "Diluted" .)