Well Ultratwinkie, I think the key word here is "realistic" not "real". The idea is to have games that are fantastic, while still functioning like they could be really happening within their own worlds... a level of consistincy that helps suspension of disbelief. I feel this is a good thing for the most part, and I see a lot of room for improvement in video games.
I think right now the next "step" in gaming is simply to be able to develop games that can do everything that current games do simultaneously. To use an example look at say Saint's Row 2 compared to Grand Theft Auto 4. People have argued back and forth about them, but the bottom line is that Grand Theft Auto 4 has better graphics quality (buildings, textures, models), BUT Saint's Row 2 is a much "busier" game world which tracks more things happening at any given moment. It would choke the system if it tried to do all of that at the same quality level of GTA IV.
Some of the compromises right now are less than satisfying. For example you have a lot of people who complain about overly cartoony, or cell-shaded graphics, however from some of what I've read that kind of "style" is also easier to render and deal with for systems than more realistic (and more detailed) models and animations.
To be honest, a lot of people complain about how a lot of current generation games look "previous gen" but we've pretty much gotten to the point where artwork is artwork, and sound is sound. It comes down to the talent of the modelers and artists more than the technology. I've heard some people complain about bad graphics for example in games that are simply highly stylized (from people who don't like the style in which they are done).
The thing is though we're not up to the point where we can see someone pretty much crank out whatever they want, whenever they want, meaning that even for game concepts that have existed for generations compromises between quality and the number of things going on have to take place.
As far as Virtual Reality goes, I don't think we're likely to see that in our lifetimes, unless some theories about medical science making us immortal pan out (but honestly with the global population issues, if such a thing is developed it would be wise to sit on it until we see space travel and colonization... we're overpopulated enough). Simply because we're not at any level where I can see commercially availible brain stimulation technology, and honestly I'd imagine that would be being used medically LONG before it became availible recreationally.
Pseudo-VR using things like goggles and gloves and such makes for better reading than it does actuality. I mean as it is right now they have enough trouble getting a bloody wiimote or light gun to work right, and Project Natal seems to be one of those "epic lulz" projects that the industry seems to be embracing to the shocked "what are they thinking" disbelief of the cosumer/user base. While history will show if I'm right (hey maybe they will sell me on the idea) I feel almost like I'm watching a head on collision of two trains while railway conducters argue profusely that the laws of Physics don't apply to Amtrak or whatever.
Truthfully I think technology is getting close to peaking, at a "practical" level for entertainment. Each generation of consoles/game machines will get longer both for economic reasons, and simply because there will be less abillity to produce dramatic, noticible improvement to sell to people. I also look at things from the perspective that technology is rushed due to the greed of manufacturers, we rarely, if ever fully see each generation of hardware used to it's full capacity by developers because it isn't around long enough.
I look back to some of the machines that were around when I was younger like the Apple II and Commodore 64. People did things with those machines that people didn't think was possible when they were first rolled out because developers were motivated over a period of years to really make them sing. Nowadays you've got new chipsets and stuff coming out every year, when I still remember as a kid: "wow 64k of Ram, what could they possibly do with it all?".
Truthfully I think the Playstation 2 was easy enough to develop for that it's the closest thing we have to those old systems, with people still finding ways to make it do relatively new things and produce marginally better games (within it's own collection).
Not purely a nostolgia rant, I don't think there will ever be a "last" generation of consoles, barring a global apocolypse, but I *DO* think we're going to see the next generation lasting as long as 10-12 years.