One embodiment of the present invention provides a switch. The switch includes a tunnel management module, a packet processor, and a forwarding module. The tunnel management module operates the switch as a tunnel gateway capable of terminating an overlay tunnel. During operation, the packet processor, which is coupled to the tunnel management module, identifies in a data packet a virtual Internet Protocol (IP) address associated with a virtual tunnel gateway. This virtual tunnel gateway is associated with the switch and the data packet is associated with the overlay tunnel. The forwarding module determines an output port for an inner packet in the data packet based on a destination address of the inner packet.