Urban fantasy, like steampunk and cyberpunk, reflects the evolving universe of fantasy fiction. As the name implies, it is not set in the idyllic countrysides of pseudo-medieval worlds. It may have elves, but they're probably going to be hard-drinking, jaded, and living in a seedy walkup whilst running from the vampire mob king they double-crossed.

Jim Butcher's Harry Dresden is an archetype of urban fantasy: a magician living openly in the big city who practices his trade with the help of some bemused non-magical types and some, eh, unusual friends. Urban fantasy allows writers to get closer to writing settings they know intimately while exercising their imagination to ponder "what if" magic were real, in our own world? What would change? What would stay the same? How would the average person react?

This is not to say all urban fantasy must be set in modern times or big cities. You can write quite good urban fantasy in a historical setting or, one supposes, the future, so long as the focus is on the fantastic rather than hard SF elements. These may start to cross the line into alternate universes or soft SF, but the key elements are a city setting and magic.

Examples:

War for the Oaks, by Emma Bull
Jim Butcher's Harry Dresden novels
The Anita Blake series by Laurell K. Hamilton, who has built a career around urban fantasy
The Merry Gentry series by Laurell K. Hamilton
The Sookie Stackhouse series by Charlaine Harris
Twilight, by Stephenie Meyer
Perdido Street Station by China Miéville
Black Blade Blues by John A. Pitts
Metal Angel by Nancy Springer

You can purchase Urban Fantasy titles through the Other Worlds Bookstore.