This is not something I would say about many galleries, but John Huddy's Illustration Cupboard is guaranteed to make everyone smile. And I mean everyone, from the hard-nosed art-market investor to the pre-school child.

Huddy specialises in "classic contemporary children's book illustration". His delightful world of magical realism, fantasy and fairytale brings out the child in all of us. But despite its playful themes and its menageries of anthropomorphic animals (sheep in jeeps, bunnies on bicycles, talking hippopotami), this is a serious business.

Look, for example, at David McKee's signed portrait. Entitled "Elmer", McKee's "patchwork elephant", seen trundling through a jungle of acid-house colour, is a global celebrity with a vast following among the under-fives. This particular masterpiece is unpublished but this year a collector bought "Elmer" for a respectable £1,500.

At the Cupboard's last show in September, Huddy presented a series of exquisite soft-focus landscapes and Toad Hall interiors from Inga Moore's illustrations for Wind in the Willows (Walker Books, 2000). A picture of Toad, roaring through the English countryside in his car - an original from the republished Kenneth ­Grahame classic - sold for £2,750.

Other artists in the gallery include Jane Ray (The King of Capri), Babette Cole (Hair in Funny Places), Anita Jeram (Guess How Much I Love You), veteran Judith Kerr (of Mog fame) and Anthony Browne, creator of the wonderfully surreal Gorilla (a touching story about a large fatherly primate). The cream of the work gets snapped up at very grown-up prices.

There is, perhaps, nothing particularly surprising about their popularity or prices. The work, after all, is original; one-offs, or limited edition prints, by world-class illustrators, many of whom have become household names. I would kill for an Anthony Browne Gorilla, and I don't have children.

What is extraordinary is the evolution of the Illustration Cupboard and its path from untested niche to international phenomenon. Now celebrating its 10th birthday, Huddy's Cupboard has helped create a vibrant market that was previously unrecognised by both artists and buyers.

With a background in Old Masters, Huddy started his career in Christie's fine art department. He left to work with a colleague, dealing in antique drawings. But when his mother, the author-publisher Delia Huddy, suggested he put together an exhibition of British book illustration, he had an inkling that this was an idea with legs. Huddy's first show, in 1996, was such a success he decided to specialise.

"Surprisingly, it hadn't really been done before," says Huddy.

There was an established market in late 19th-century and early 20th-century children's book art, especially in classics such as John Tenniel's Alice in Wonderland originals (first published in 1865), and EH Sheperd's classic Winnie the Pooh drawings (1926). But nobody specialised in contemporary work, at least in Britain, which, according to Huddy, is home to "the best illustration and the best illustrated books in the world".

"There are illustration galleries in America, one in Australia, but there was nothing in Europe," he says.

His first task was to persuade artists that there was a market for their work. "Some had exhibited at the odd show, but actually having somebody represent their work, as part of a focused business, was ground-breaking stuff."

Even now he is expanding his list of artists, many of whom have not sold their work before. But there are others who can't be persuaded to sell originals (Raymond "The Snowman" Briggs, for example, has never sold a piece, other than animation film cells).

But collectors, among which there is a growing band of specialists, no longer need educating. Huddy cites a new version of Treasure Island, illustrated by award-winning Australian Robert Ingpen, as a benchmark of the market's enthusiasm. "The book had hardly even come out, and we had collectors phoning up asking whether they could buy this page or that page," he says.

The Illustration Cupboard doesn't have a gallery in the conventional sense. Huddy does most of his wheeling and dealing from a small office off Regent Street or from his flat on the top floor of a Victorian townhouse in Olympia. He entertains buyers by appointment but much of his ­catalogue is on the web.

The last show, like many of its predecessors, was hosted by Thomas ­Williams Fine Art in Old Bond Street. The next, the Cupboard's annual winter exhibition, opens next week at the Air Gallery in Dover Street (before moving on to the Light Gallery in Porchester Place).

The winter show, a 10th anniversary special, features an eclectic mix of artists such as Cupboard stalwarts Anita Jeram (showing newly released watercolours from Happy Birthday Contrary Mary) and gallery newcomers, including a trio of Dublin illustrators, PJ Lynch, Niamh Sharkey and Jonathan Barrie. Jan Pienkowski is showing artwork from the just-published Puffin classic, The Fairy Tales.

One of the highlights of the show is a collection of three-dimensional pieces by Lauren Child, well known to the under-nines for her distinctive layered collages, using pencil, magazine ­cuttings and computerised imagery (as seen in Clarice and the Bean and Definitely Daisy, among other titles).

For her new book, The Princess and the Pea, a collaboration with photographer Polly Borland (published by ­Puffin this week), she created a series of doll's house-size room sets, furnished with a patchwork of fabrics, miniatures and printed paper figures. Of the five on show, only one, The Vain Princess, is to be sold. Offered at a "blind auction", with a reserve of £1,500, the proceeds will go to Cancer Research.

Child admits to being a reluctant seller. "In printed illustration, the work is never reproduced as brightly or as beautifully as the original," she says. "And I like to be able to refer back to old pieces. I have sold work before but I have often regretted it, so I am now very careful about what I sell."

She also wonders whether the investment value identified by Huddy's collectors makes it sensible for artists to hang on to their work for posterity. She does, however, appreciate that the chance to exhibit gives illustration a new dimension outside children's publishing and broadens its audience.

"In the rest of the gallery world, illustration is generally looked down on as a poor man's art," she says. The Illustration Cupboard is helping to change that perception, as did 2002's Magic Pencil, a touring British Council exhibition curated by Children's Laureate Quentin Blake (to "increase awareness of the art of illustration").

"A lot of people still think that book illustration is all bunnies and Harry Potter," says Child. But when seen in the flesh, it's almost impossible not to recognise the skill and talent that goes into the work, most of it by gifted artists not only working in inks, watercolours or, in Niamh Sharkey's case, oils on prepared paper but also using vivid imaginations and stunning colours.

"In 50 years, I know some of these terrific artists will be seen in the same way that we now look at illustrators from the 1920s," says Huddy. "Their works will become classics and I think the prices will reflect that."

Artists worth investing in, he suggests, include Angela Barratt, Robert Ingpen, Michael Foreman, PJ Lynch, Satoshi Kitamura, Victor Ambrus and Anthony Browne among others.

It is still a very affordable market. "I'm a great believer in offering something for everyone," says Huddy, whose next show has pieces priced at less than £100 for a small vignette by, say, Anita Jeram, up to £3,000 fordouble-page spreads or front covers. For many buyers, however, the market has more to do with mice or Mogs than money. The beguiling charm of small furry animals or evocative fairytale landscapes, tugs at the heart strings and the wallet.

"A lot of purchases are driven by nostalgia. "People want to buy things they grew up with or pieces they know their children will enjoy," says Huddy.

"I envy these children. It's such a special thing, to own an original from a book you love, something you will always have and can pass on to your own children."