Brighton siege: Man found dead, woman held hostage, police shot | video

The officers killed the gunman during the shootout. Two were later taken to hospital with gunshot wounds, while the other officer was treated at the scene.

Police had not confirmed the identity of the gunman but a man reportedly called Channel Seven newsroom during the standoff and said "This is for IS. This is for al-Qaeda".

Police are investigating whether the incident is terror-related and counter-terror investigators were on the scene.

The suspect was shot dead by police in a volley of gunfire after the woman was taken hostage at the Buckingham Serviced Apartments in Bay Street.

It is understood a man shot dead by the gunman was an employee of the serviced apartments. The female hostage is also believed to have worked at the apartments.

Police had arrived at the apartment block to find a man's body in the foyer while the suspect was holed up in one of the apartments with the woman.

Dozens of gunshots rang out just after 6pm in Bay Street with crowds of people fleeing and taking refuge in a nearby Coles supermarket.

A number of residents were trapped in the apartment block during the shootout.

About 6.20pm police removed what appeared to be a body on a stretcher from the apartment block.

Deputy Police Commissioner Andrew Crisp said police were investigating the relationship between the gunman and the female hostage, who is aged between 20 and 30.

The call to Channel Seven is believed to have come from within the building. A woman could be heard screaming in the background.

Two of the shot police officers were taken to hospital and another treated at the scene, police said. None has life-threatening injuries.

Jack Reid, 20, of Brighton said he and his friends had run for their lives after hearing gunfire.

"I was standing on the corner across the road," he said.

"I saw police pull out their guns, I heard about three dozen gun shots. I got really scared and ran across the road. Police were telling everybody to get into the Coles supermarket so me and mates just ran."

Kate Forster said she saw fire crews hiding behind their truck, empty cars left in the middle of the road and people stuck in the building next door to the siege.

"Can see them in the window looking distressed," she said from the scene.

Police were called to the serviced apartments at 4pm after reports of an explosion. 

Police then tried to negotiate with a man in one of the apartments who had taken a woman hostage.

The Nepean Highway and Hampton Street remain closed. 

Graeme Hisgrove said he, his wife and teenage children had to hit their lounge room floor because of a volley of gunfire coming from the serviced apartments next to their house just after 6pm.

"We've all hit the deck on our lounge floor," Mr Hisgrove said.

He said tactical police were inside his property against the fence line.

Mr Hisgrove said he heard a single gunshot on the other side of his fence between 4 and 4.30pm.

"It was one single bang. It was massive," he said.

He went out the front of his house and police had already surrounded the premises.

He said he and his family were now "waiting it out" inside their home.

"We're a bit on edge," he said.

Antonia Waite, who lives off Bay Street, said her daughter was in the front yard when police, armed with "big guns", drove past about 4.30pm and told her to "go inside and lock the doors".

A number of callers said they saw undercover armed police with bulletproof vests running up the street.

One person said police had arrested a person and who was handcuffed at a bus stop in Bay Street.

Another caller, Georgie, said she had seen police officers on their hands and knees with guns drawn at the entrance to the apartment block.

All northbound lanes of the highway were closed at Bay Street, a VicRoads spokesman said.

Hampton Street was also blocked to motorists.

The police spokeswoman said roads would be closed "for some time".