Manager Roberto Mancini was again left to rue a costly decision to deploy a three-man defence as the Spanish giants tore into the hosts in the early stages.
Karim Benzema struck and Real should have had more in a devastating spell but City grew in confidence after switching formations and Sergio Aguero levelled from the spot after Alvaro Arbeloa was sent off.
City poured forward in search of a winner in the closing stages but it was not to be and the result leaves them with just three points in Group D and unable to progress.
Mancini reverted to the controversial 3-5-2 system which proved so troublesome as City slumped to a damaging defeat at Ajax earlier in the competition.
He also fielded Edin Dzeko up front in place of Carlos Tevez in the hope of exploiting the Bosnian's aerial presence - not to mention his recent good form - but any illusion of City solidity was soon shattered.
Beginning what proved a tortuous period for the home side, Fabio Coentrao first got behind the City defence after seven minutes but Vincent Kompany managed to cut out his cross.
Benzema then broke clear but Aleksandar Kolarov managed to get back to prevent him cutting inside and shooting.
City failed to heed either of those warnings and were soon punished.
Maicon was left well out of position as Benzema peeled away from him to turn in a curling deep cross from Angel di Maria at close range.
City were fortunate things did not get immediately worse as Cristiano Ronaldo - making his first appearance in Manchester since leaving United in 2009 - beat Maicon and Zabaleta to cross but Sami Khedira side-footed across goal.
Ronaldo then showed some trademark dazzling footwork to skin Kompany and provide for Khedira again but the German headed inches wide of the near post.
Ronaldo thought he had doubled the lead himself when he raced through and deftly lobbed Joe Hart but Matija Nastasic chased back to hook off the line. The Portuguese got a second opportunity but drilled wide.
City then started to gain a foothold but remained vulnerable to the lightning Real counter-attacks.
Di Maria broke away from Yaya Toure and found Ronaldo, who laid off for Luka Modric to shoot but Kompany got his body in the way.
City finally made their presence in the game known after 21 minutes as Aguero turned to shoot after combining with David Silva but Iker Casillas palmed over.
Normal service was soon resumed as Khedira went through one on one with Hart but the keeper was alert and smothered his shot.
Mancini had clearly seen enough and abandoned his gameplan, moving Zabaleta to the left and switching to a flat back four.
Almost immediately Maicon showed his attacking prowess as he surged down the right and played a one-two before shooting wide.
City earned a free-kick just after the half-hour when Arbeloa pulled back Aguero but Kolarov curled his shot wide.
Silva tricked his way past two defenders to create a chance for Dzeko but the striker's first-time shot was poor.
The change of formation appeared to help City and they looked stronger as the first half drew to a close but Real had another opening when Benzema shot over.
City started the second half strongly with Maicon twice getting forward to deliver dangerous crosses.
With Javi Garcia on in place of Kolarov, Toure also got forward to support the attacks more.
Silva again weaved his way through the defence to tee up Aguero but Casillas denied the striker.
City were much more of a force in the game but always looked vulnerable on the counter-attack.
Ronaldo picked out Khedira with another cross but he was unable to beat Hart with his header.
Mancini sent Tevez on but Aguero continued to look the main threat and he seemed certain to score as he reached Maicon's deflected cross, but Casillas produced a brilliant point-blank save.
City were almost caught out again by Ronaldo, whose dipping shot troubled Hart but City cleared before he got a second attempt.
The hosts dragged themselves back level when referee Gianluca Rocchi pointed to the spot after Dzeko played in Aguero from a long Toure ball.
Aguero went down after tangling with Arbeloa and what seemed a harsh decision was compounded for Real as the former Liverpool man was shown the red card.
Aguero coolly converted to level the scores.
City pushed for a winner with Dzeko getting into a good position and Tevez shooting at Casillas.
Coentrao also made a good interception to prevent a Maicon cross reaching Dzeko.
Toure shot well over in injury time as City's night ended in disappointment and Real's place in the last 16 was confirmed.