The stable expansion of tissue-specific stem cells in vitro has contributed to research on several organs. Alveolar epithelial type II (AT2) cells function as tissue stem cells in the lung, but robust models for studying human AT2 cells are lacking. Here we report a method for the efficient generation and long-term expansion of alveolar organoids (AOs) harboring SFTPC alveolar stem cells derived from human induced pluripotent stem cells (hiPSCs). hiPSC-derived SFTPC cells self-renewed, with transcriptomes and morphology consistent with those of AT2 cells, and were able to differentiate into alveolar epithelial type I (AT1)-like cells. Single-cell RNA-seq of SFTPC cells and their progenitors demonstrated that their differentiation process and cellular heterogeneity resembled those of developing AT2 cells in vivo. AOs were applicable to drug toxicology studies recapitulating AT2-cell-specific phenotypes. Our methods can help scientists overcome the limitations of current approaches to the modeling of human alveoli and should be useful for disease modeling and regenerative medicine.