Species diversity may play an important role in the modulation of pathogen transmission through the dilution effect. Infectious disease models can help elucidate mechanisms that may underlie this effect. While many modeling studies have assumed direct host-to-host transmission, many pathogens are transmitted through the environment. We present a mathematical modeling analysis exploring conditions under which we observe the dilution effect in systems with environmental transmission where host species interact through fully or partially overlapping habitats. We measure the strength of the dilution effect by the relative decrease in the basic reproduction number of two-species assemblages compared to that of a focal host species. We find that a dilution effect is most likely when the pathogen is environmentally persistent (frequency-dependent-like transmission). The magnitude of this effect is strongest when the species with the greater epidemic potential is relatively slow to pick up pathogens in the environment (density-dependent transmission) and the species with the lesser epidemic potential is efficient at picking-up pathogens (frequency-dependent transmission). These findings suggest that measurable factors, including pathogen persistence and the host’s relative efficiency of pathogen pick-up, can guide predictions of when biodiversity might lead to a dilution effect, and may thus give concrete direction to future ecological work.