The girls' grandmother turns out to be a member of a witches' coven that has called forth the demon who demands that he be provided with a male child. The demon kills the girls' father figure and mother, and the girls, seemingly brainwashed, live with their grandmother while Toby watches and waits.
In a prologue, taking place before the events of the first two films, Katie (Katie Featherston) brings a box of old VHS tapes to store in her sister Kristi's (Sprague Grayden) basement. Katie notes that she doesn't really remember what was on them. Months later after Kristi's house is ransacked (an event seen in the second film), Kristi's husband notices that the tapes are now missing. The rest of the film depicts what was on those tapes, which were recorded during Katie and Kristi's childhood.
Dennis (Christopher Nicholas Smith) is the boyfriend of Katie and Kristi's (played as kids by Chloe Csengery and Jessica Tyler Brown) mother Julie (Lauren Bittner), as well as an amateur filmmaker, who makes wedding videos. Dennis decides to start filming around the house after he starts hearing noises and he also notices, in a video recorded during an earthquake, dust landing on an invisible figure. The strange activity begins at the same time Kristi gets a new invisible friend named "Toby".
Dennis sets up a camera in both the master and child's bedrooms, as well as another camera attached to a fan that records the kitchen and living room. As with the other films, the activity starts off small and progressively gets worse. In addition, on many nights Kristi is seen doing things for "Toby."
At the first sign of true paranormal activity, Dennis is encouraged by his friend, and co-worker, Randy (Dustin Ingram) to tell Julie about the haunting. However, Dennis doesn't, afraid it would freak her out. One day, Kristi goes comatose after telling "Toby" she wasn't going to do something and that she'd never talk to him again. Dennis and Julie take Kristi to the doctor, while Randy watches Katie. Katie gets Randy to play "Bloody Mary" with her in the bathroom, during which both are attacked by the demon and Randy ends up scratched. This scares him enough to pack up his things from Dennis' editing room and leave, warning Dennis that he should just leave the presence alone.
Dennis finally tries to show Julie his footage, as well as tell her some information he found out about a coven formed in the 1930s, which used similar symbols to one he found drawn in the girls' bedroom. However, she had enough of his attempts to scare the children and told him to stop filming. Meanwhile, the demon begins focusing its attacks on Katie and keeps attacking her until Kristi agrees to do what "Toby" asked of her.
Kristi asks Julie to go to her grandmother's house. Julie initially refuses, but decides to go after the demon finally reveals itself to her by levitating all the kitchen furniture and dropping it. While at her grandmother's house, Kristi is shown trying on a wedding veil. When playfully asked who's the groom, she replies that "Toby" is.
During the night, Dennis finds himself alone after Julie leaves the bedroom. In addition, he finds the girls are not in their bed. He walks throughout the house trying to locate everyone. He sees a dark figure in another room, however there's nothing there when he enters the room. However, he does see that the pictures were removed from the wall and the symbol the coven used, as well as a pentagram, were drawn behind where the pictures were.
Dennis makes his way his way outside and enters into a room on the other the other side of the house, where he finds himself surrounded by a group of women (presumably the coven). He runs back the way he came and he finds Julie at the top of the stairs levitating off the ground. He starts going up to her and she is pushed towards him.
During this time, it is shown that some sort of ceremony is happening outside by a fire. Dennis finally finds Kristi and comforts her before he sees Katie crying by the stairs. Dennis goes up to her and it is revealed that Katie is possessed by the demon and sends Dennis flying back and he drops his camera. Badly injured, Dennis starts crawling forward and Katie and Kristi's grandmother walks in front of him. Suddenly, Dennis is killed by being bent backwards and Katie and Kristi take their grandmother's hand and walk up the stairs, with Kristi saying "come on Toby." The demon is heard coming towards the camera, which ends in static.
(I should also note that it may be a coincidence, but the ending of the film is very similar to that of The Last Exorcism.)
Thanks Sean (and Evan)!