Increasing drought frequency is a major driver of changes in forest structure and has been implicated in the decline of the endangered tree species, Eucalyptus gunnii ssp. divaricata (McAulay & Brett) in the Central Plateau region of Tasmania, Australia. In this study, we examined patterns of regeneration, aspects of the water relations of E. gunnii ssp. divaricata and its replacement Eucalyptus pauciflora and, whether shifts in stand dominance have occurred where the subspecies co-occurs with E. pauciflora could be related to recent changes in climate. Successful E. gunnii ssp. divaricata seedling regeneration was restricted to micro-sites with relatively deep soils within slight depressions. In contrast, poor E. gunnii ssp. divaricata regeneration and declining adult cohorts of this species all occurred on steeper, concave micro-sites with shallow soils. This apparent shift in suitable regeneration micro-site, from sites with shallow to deeper soils, may be linked to an observed 25% reduction in summer rainfall over the last 50 years. On slopes surrounding waterlogged depressions where E. gunnii ssp. divaricata co-occurs with E. pauciflora, E. pauciflora was in higher abundance than E. gunnii ssp. divaricata in small adult and sapling size-classes, compared with the adult cohorts (>30 cm d.b.h.), a trend consistent with a shift in stand dominance. Despite existing paradigms related to differential drought tolerance between these two species as a driver of this shift in stand dominance, there were no differences in predawn (Ψpd) water potentials between species. Furthermore, pressure–volume analysis showed that E. gunnii ssp. divaricata had lower values for osmotic potential at turgor loss point (−2.33 ± 0.06 MPa) than E. pauciflora (−2.13 ± 0.03 MPa), suggesting that E. gunnii ssp. divaricata may be more drought tolerant than E. pauciflora, in contrast to the prevailing paradigm that it is more susceptible to drought than E. pauciflora.