I believe that your brain is rendering the reality for your consciousness even when you are awake. There is a lot of filtering and processing between your senses and your consciousness. For instance, your eyes produces a lot of noise which is filtered away. They have a blind spot [1], but your consciousness is not even aware of it! So, what you see when you are awake is not really the noisy distorted vision that your eyes have.
In addition to that low level smoothing and filtering, your subconscious has reconstructed completely the reality for your conscious mind: "This is because our brains consist of two relatively distinct regions. One, the cognitive unconscious, makes informed guesses and delivers them to the second, conscious part, which supports our awareness of what we are seeing while knowing little or nothing of how what we see has been constructed." [2]
"All we’re actually doing is seeing an internal model of the world; we’re not seeing what’s out there, we’re seeing just our internal model of it. And that’s why, when you move your eyes around, all you’re doing is updating that model." [3]
So, when your are dreaming, the subconscious mind is just "rendering" something else than reality for your conscious mind.
[1] http://io9.com/5804116/why-every-human-has-a-blind-spot---an...
[2] http://serendip.brynmawr.edu/exchange/node/2604
[3] http://aminotes.tumblr.com/post/7722763662/david-eagleman-on...
I always wonder about this. It occurs to me that it may seem to perfectly real because the brain is able to reproduce all, or close to all, of the features it would use to try to classify that object in real life, which would lead to it seeming like a 100% match, or 100% real.
I guess you could think of it as passing a dataset back into a machine learning algorithm that was just trained using that dataset.
It also makes me wonder what would happen if you try to conjure a specific animal or place that you know a little about, but are fuzzy details. Would you brain feel like "yup. this is the thing because it's absolutely everything I know about the thing; it's perfect" or would it have problems?
Of course, I'm not an expert in brains or machine learning, so this is just my wild speculation on my thought.