Human lung organoids (hLOs) derived from induced pluripotent stem cells (iPSCs) are of great interest, as they inform lung development, such as differentiation of lung epithelial subtypes in the distal alveolar unit. An unaddressed question is whether introducing endothelial cells (ECs) and vascularization provides a better representation of hLOs. Here we describe a method in which vessels become integrated with hLOs. hLOs were generated by combining human iPSC–derived lung progenitor cells (LPs) with ECs at varying LP:EC ratios. At the optimal combination of both cells, we observed vessel infiltration of hLOs compared to without ECs. Red blood cells were seen in hLOs implanted into kidney capsules of NOD/SCID mice. Both human and mouse ECs conjoined to form chimeric vessels in hLOs. The vascularized hLOs showed alveolar type II epithelial (ATII) cells and ATI cells, although there was no difference in 1:1 ATII/ATI ratio. We observed primitive airway sacs with alveolar epithelial cells lining the lumen of vascularized hLOs. Electron microscopy revealed surfactant production in ATII cells of vascularized hLOs in contrast to absence of vessels. The vascularized hLOs also mounted a robust inflammatory response characterized by influx of mouse neutrophils after challenging mice with LPS. Thus, interactions of ECs with LPs generated vascularized hLOs that induced ATII and ATI differentiation, although not reaching to the ratio of 1:9 seen in mature human lungs. hLOs also showed the LPS induced inflammatory response upon transplantation into recipient mice. Our results show the potential of vascularized hLOs for studying human lung development and inflammatory lung injury.