Urethral hypoplasia, including failure of urethral tube closure, is one of the common phenotypes observed in hereditary human disorders, the mechanism of which remains unclear. The present study was thus designed to study the expression, functions, and related mechanisms of the LIM homeobox transcription factor Isl1 throughout mouse urethral development. Results showed that Isl1 was highly expressed in urethral epithelial cells and mesenchymal cells of the genital tubercle (GT). Functional studies were carried out by utilizing the tamoxifen-inducible Isl1-knockout mouse model. Histological and morphological results indicated that Isl1 deletion caused urethral hypoplasia and inhibited maturation of the complex urethral epithelium. In addition, we show that Isl1-deleted mice failed to maintain the progenitor cell population required for renewal of urethral epithelium during tubular morphogenesis and exhibited significantly increased cell death within the urethra. Dual-Luciferase reporter assays and yeast one-hybrid assays showed that ISL1 was essential for normal urethral development by directly targeting the Shh gene. Collectively, results presented here demonstrated that Isl1 plays a crucial role in mouse urethral development, thus increasing our potential for understanding the mechanistic basis of hereditary urethral hypoplasia.