The top-seeded Shelton lost 7-5 6-3 to Sebastian Baez of Argentina, who is unseeded and ranked 39th.
Shelton led 1-0 in the second set on Thursday night when torrential rain caused the match to be suspended. When it resumed on Friday, Baez served to level the match, then broke the American to lead 2-1.
Third-seeded Jakub Mensic will play Fabian Marozsan and Baez will play American Marcos Giron in the Auckland semi-finals.
The 23-year-old Shelton, the top-ranked American on tour ahead of No. 9 Taylor Fritz, now heads to the Australian Open in which he will play Ugo Humbert of France in the first round.
At a news conference in Auckland, Shelton said he believes there are young players capable of bridging the gap to Jannik Sinner and Carlos Alcaraz, who have won the last eight grand slam singles titles between them.
He hopes to be one of them.
"They've certainly been ahead of the pack the last couple years," Shelton said. "But in my mind there's definitely guys who can come up there and challenge, young guys who are playing great, better and better every year.
Alcaraz is 22 and Sinner 24.
"To be doing what Alcaraz and Sinner are doing at such a young age is not normal but there's so many young guys who haven't fully developed or we haven't seen their best tennis yet."
Shelton said the 2025 season "was a great stepping stone for me ... there's so many things I improved on in 2025 versus 2024.
"And, for me, it's not all about the results. It's more what I find in my game, the things that I figure out," Shelton added. "So there is a lot to be able to build off of this year."
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