The VS 2005 Web Application Project option provides an alternate web project model option to the VS 2005 Web Site Project Model that ships built-into VS 2005. VS 2005 Web Application Projects support the same project, build and compilation semantics as the VS 2003 web project model. Specifically:
All files contained within the project are defined within a project file (as well as the assembly references and other project meta-data settings). Files under the web’s file-system root that are not defined in the project file are not considered part of the web project.
All code files within the project are compiled into a single assembly that is built and persisted in the \bin directory on each compile. Incremental publishing of compiled apps is fully supported within the IDE (see this post for details).
The compilation system uses a standard MSBuild based compilation process. This can be extended and customized using MSBuild extensibility rules. You can control the build through the property pages, name the output assembly or add pre- and post-build action rules. It can also provide much faster compile times for large web projects.
Scott also notes that WAP will be included with Visual Studio SP1, and will be fully supported going forward.
Last, but certainly not least, is the exciting news that WAP supports edit and continue for web projects, using the built-in Visual Studio Web Server! Scott's post contains a walkthrough of enabling and using edit and continue.