Reciprocal signaling between the lung mesenchyme and epithelium is crucial for differentiation and branching morphogenesis. We hypothesized that the combination of signaling pathways comprising early epithelial-mesenchymal interactions and a 3D spatial environment are necessary for an efficient induction of embryonic and induced pluripotent stem cells (ESCs and iPSCs) into a lung cell phenotype with hallmarks of the distal niche. Aggregating early, but not late, embryonic lung mesenchyme with endoderm-induced mouse ESCs and iPSCs for 6 days resulted in organization into tubular structures and differentiation of the tubular lining cells to an NKX2-1(+)/SOX2(-)/SOX9(+)/proSFTPC(+) lineage. Over 80% of the endoderm-induced cells committed to an NKX2-1(+) lineage. Electron microscopy analysis demonstrated numerous multivesicular bodies and glycogen deposits in the tubular lining cells, characteristic features of type II epithelial cell progenitors. Using soluble FGFR2 receptor antagonists, we demonstrate that reciprocal fibroblast growth factor (FGF) 2, 7, and 10 signaling is essential for differentiation of endoderm-induced cells to an NKX2-1(+)/proSFTPC(+) phenotype within 3D aggregates. Only FGF2 was able to commit endoderm-induced cells in monolayer cultures to an NKX2-1(+) lineage, however with a significant lower efficiency (∼16%) than seen with mesenchyme. Thus, while FGF2 signaling alone can induce a primed population of ESCs and iPSCs, the cells do not differentiate to distal lung epithelial progenitors with the same efficiency and level of maturity that is achieved when the complex tissue and 3D environment of the developing lung is more accurately recapitulated.