This is between a toilet and a bathtub. For whatever reason moisture is condensing here everyday. It is dry after a shower but at some point overnight it starts condensing. My main question is what is the best way to repair this spot? Will I need to remove the drywall or should I attempt to sand this area down and repaint?
Sanding and repainting will only fix it cosmetically. You might have a bigger issue with a leak in the wall or condensation from the toilet. OR water overspray from your showering.
If you use a shower curtain, you can address the spraying by installing pre-made plastic corners on the top outer edge of your tub. If that is the only issue, after that you can do a cosmetic fix....(is the wall plaster so you mention sanding?)
Otherwise you can investigate the toilet for condensation. You can thereafter purchase or rent an inspection camera, drill a 3/4 -inch hole in the wall and look in the wall to find any interior pipe leaks. You may have to cut the wall open. If there is an access panel on the opposite side of this wall, then open it and look around. Good luck and let us know what you find.