Formation of the kidney requires reciprocal signaling among the ureteric tubules, cap mesenchyme and surrounding stromal mesenchyme to orchestrate complex morphogenetic events. The protocadherin Fat4 influences signaling from stromal to cap mesenchyme cells to regulate their differentiation into nephrons. Here, we characterize the role of a putative binding partner of Fat4, the protocadherin Dchs1. Mutation of Dchs1 in mice leads to increased numbers of cap mesenchyme cells, which are abnormally arranged around the ureteric bud tips, and impairment of nephron morphogenesis. Mutation of Dchs1 also reduces branching of the ureteric bud and impairs differentiation of ureteric bud tip cells into trunk cells. Genetically, Dchs1 is required specifically within cap mesenchyme cells. The similarity of Dchs1 phenotypes to stromal-less kidneys and to those of Fat4 mutants implicates Dchs1 in Fat4-dependent stroma-to-cap mesenchyme signaling. Antibody staining of genetic mosaics reveals that Dchs1 protein localization is polarized within cap mesenchyme cells, where it accumulates at the interface with stromal cells, implying that it interacts directly with a stromal protein. Our observations identify a role for Fat4 and Dchs1 in signaling between cell layers, implicate Dchs1 as a Fat4 receptor for stromal signaling that is essential for kidney development, and establish that vertebrate Dchs1 can be molecularly polarized in vivo.