Kohlschreiber, ranked 28 in the world and the defending champion, notched up his first-ever victory over Nadal in nine encounters, winning 6-3, 6-4.
Second seed and five-time champion Roger Federer survived 25 aces from Canadian fifth seed Milos Raonic in a come-from-behind 6-7 (4/7), 6-4, 7-6 (7/3) win.
Federer will next face Russia's Mikhail Youzhny, who he has beaten in their last 12 meetings, while Kohlschreiber will take on either the Czech Republiuc's Tomas Berdych or Germany's injury-prone former world number two Tommy Haas.
"I said it was going to be tough," Nadal said. "He plays well on this court. You just have to congratulate him. He played very aggressive, served well, returned well. He played better than me.
"I was suffering when he was serving. I didn't have that energy to change the situation."
Nadal said he would now be heading back to his home in Mallorca to rest up.
"I can't practise on grass there but it's better not to practise for a few days. It's time to rest with my family, friends, to relax.
"I've played almost every match possible since Indian Wells. When I'm ready to come back, I'll go to Wimbledon."
Nadal, who captured a record seventh Roland Garros title on Monday, suffered an even worse result when he last played in Halle seven years ago, losing in the first round to Alexander Waske.
This time around, Nadal was in difficulty from his first service game and was quickly 2-0 down, Kohlschreiber going on to wrap the first game up in little more than 30 minutes.
After saving two breaks in the opening game of the second set, Nadal then missed the chance to break the German three times on his serve in the fourth game, and Kohlschreiber kept his nerve to beat the Spaniard comfortably.
Federer clinched a third successive win over the highly-rated, 21-year-old Raonic.
He had also dropped the opening set to the Canadian in his two previous meetings, in Indian Wells and Madrid this year.
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