Intramuscular injection of bone morphogenetic proteins (BMPs) has been shown to induce ectopic bone formation. A chondrogenic phase is typically observed in this process, which suggests that there may exist a chondrogenic subpopulation of cells residing in skeletal muscle. Two prospective cell populations were isolated from rat skeletal muscle: fascia-derived cells (FDCs), extracted from gluteus maximus muscle fascia (epimysium) and muscle-derived cells (MDCs) isolated from the muscle body. Both populations were investigated for their cell surface marker profiles (flowcytometry analysis), proliferation rates as well as their myogenic and chondrogenic potentials. The majority of FDCs expressed mesenchymal stromal cell markers but not endothelial cell markers. FDCs underwent chondrogenic differentiation after BMP4 treatment in vitro, but not myogenic differentiation. Although MDCs showed chondrogenic potential, they expressed the myogenic cell marker desmin and readily underwent myogenic differentiation in vitro; however, the chondrogenic potential of the MDCs is confounded by the presence of FDC-like cells residing in the muscle perimysium and endomysium. To clarify the role of the muscle-derived myogenic cells in chondrogenesis, mixed pellets with varying ratios of FDCs and L6 myoblasts were formed and studied for chondrogenic potential. Our results indicated that the chondrogenic potential of the mixed pellets decreased with the increased ratio of myogenic cells to FDCs supporting the role of FDCs in chondrogenesis. Taken together, our results suggest that non-myogenic cells residing in the fascia of skeletal muscle have a strong chondrogenic potential and may represent a novel donor cell source for cartilage regeneration and repair.