Herzog made the comments while laying out his new security and diplomatic initiative that has caused waves in Israeli politics and sparked criticism from within his own party.
His plan comes amid four months of Palestinian knife, gun and car-ramming attacks targeting Israelis -- violence that Herzog says amounts to a new "intifada," or uprising.
The head of the Labour-led Zionist Union coalition said he still wants a two-state solution, but does not believe Israeli Prime Minister Benjamin Netanyahu and Palestinian president Mahmud Abbas are capable of a breakthrough.
Herzog said the Palestinians must also be given more civilian authority in the West Bank itself as part of "confidence-building measures", though he stressed the Israeli army would continue to operate anywhere it sees necessary in the territory.
Also Read
Beyond that, he wants a security conference including "all moderate parties in the region" to tackle a range of issues in the Middle East.
"I believe that we have to be realistic," Herzog said at a news conference to unveil his initiative to foreign journalists.
He said his initiative was aimed at preserving the two-state solution while recognising progress cannot be made until the violence stops. He argued that "no other party or leader has presented a plan that is realistic."
Herzog's Labour adopted his proposals on Sunday, though some from within the party and other leftwing politicians say they amount to giving up on negotiations and moving too far to the right in hopes of gaining political ground on Netanyahu.
But he has faced criticism over the government's inability to halt the wave of Palestinian attacks.
Israeli-Palestinian negotiations have been at a complete standstill since peace talks collapsed in April 2014.