"Prices have yet to stabilize and thus are likely to overshoot our original estimates further," Goldman analysts said in a report.

Appraisal values have fallen 25 percent. Goldman expects a decline from peak levels in 2007 of 40 percent to 42 percent, a much steeper declined than the 28 percent it expected.

Sales prices have plunged 39 percent from their peak prices verses Goldman's prior estimate 24 percent.

At the same time, vacancy rates have risen 35 percent versus the 17 percent Goldman had expected. Rents have fallen by 9 percent, translating into fundamentals that have deteriorated by more than twice the rate Goldman anticipated.

Goldman expects $287 billion of losses on commercial real estate and construction loans.

Goldman said it favors consumer-focused large banks, such as JPMorgan Chase & Co (JPM.N) and Bank of America Corp (BAC.N) over regional banks such as Western Alliance Bancorp (WAL.N) and Marshall & Ilsley Corp (MI.N), which are heavily focused on real estate.

"Construction is still our main issue," the analysts wrote in a research report. "Just like in residential, we expect losses will be high and come on a two-to-three year lag from the market peak, which translates to (the second half of 2009 and through 2010)."

Regional banks are overweight on construction loans versus big banks, the report said.

As far as insurance companies, Goldman favors Arch Capital Group Ltd (ACGL.O), Lincoln National Corp (LNC.N) and RenaissanceRe Holdings Ltd (RNR.N) over real estate investment laden Allstate Corp (ALL.N) and Hartford Financial Services Group Inc (HIG.N).

It suggested avoiding most real estate investment trusts and retain only those with very strong balance sheets, including Taubman Centers Inc (TCO.N) and Essex Property Trust Inc (ESS.N).