Recent studies have demonstrated that adipose-derived mesenchymal cells (AMCs) offer great promise for cell-based therapies due to their ability to differentiate towards bone, cartilage and fat. Given that cartilage is an avascular tissue and mesenchymal cells experience hypoxia during prechondrogenic condensation in endochondral ossification, the goal of this study was to understand the influence of oxygen tension on AMC differentiation into bone and cartilage. In vitro chondrogenesis was induced using a three-dimensional micromass culture model supplemented with TGF-1. Collagen II production and extracellular matrix proteoglycans were assessed with immunohistochemistry and alcian blue staining respectively. Strikingly, micromasses differentiated in reduced oxygen tension (2% O₂) showed markedly decreased chondrogenesis. Osteogenesis was induced using osteogenic media supplemented with retinoic acid or vitamin D and was assessed by alkaline phosphatase activity and mineralization. AMCs differentiated in both 21% and 2% oxygen environments. However, osteogenesis was severely diminished in a low oxygen environment. These data demonstrated that hypoxia strongly inhibits in vitro chondro- and osteogenesis in AMCs.