This study describes the physiological response of two co-occurring tree species (Eucalyptus marginata and Corymbia calophylla) to seasonal drought at low- and high-quality restored bauxite mine sites in south-western Australia. Seasonal changes in photosynthesis (A), stomatal conductance (gs), leaf water potential (ψ), leaf osmotic potential (ψ), leaf relative water content (RWC) and pressure–volume analysis were captured over an 18-month field study to (i) determine the nature and severity of physiological stress in relation to site quality and (ii) identify any physiological differences between the two species. Root system restriction at the low-quality site reduced maximum rates of gas exchange (gs and A) and increased water stress (midday ψ and daily RWC) in both species during drought. Both species showed high stomatal sensitivity during drought; however, E. marginata demonstrated a higher dehydration tolerance where ψ and RWC fell to −3.2 MPa and 73% compared with −2.4 MPa and 80% for C. calophylla. Corymbia calophylla showed lower gs and higher ψ and RWC during drought, indicating higher drought tolerance. Pressure–volume curves showed that cell-wall elasticity of E. marginata leaves increased in response to drought, while C. calophylla leaves showed lower osmotic potential at zero turgor in summer than in winter, indicating osmotic adjustment. Both species are clearly able to tolerate seasonal drought at hostile sites; however, by C. calophylla closing stomata earlier in the drought cycle, maintaining a higher water status during drought and having the additional mechanism of osmotic adjustment, it may have a greater capacity to survive extended periods of drought.