كتب : Hatem Maher
Salva Ballesta notched what proved to be the winner early in the first-half to widen Real's misery.
The result put Real in fourth place of the league table with 38 points, one behind third-placed Valencia and four behind leaders Barcelona, who face Osasuna later on Sunday.
The home crowd was stunned after just 11 minutes when Levante were awarded a spot-kick after Malian midfielder Mahamadou Diarra made a reckless challenge on Italian player Damiano Tommasi.
Ballesta stepped-up and converted the ball into the right bottom corner of the net.
After conceding the opener, Real Madrid pushed forward searching for the equalizer but were frustrated by Levante's compact defense.
Los Meringues appealed for penalty in the 25th minute, claiming that skipper Raul was pushed when trying to convert home Gonzalo Higuain's low cross but the referee waved play on.
Real keeper Ilker Casillas saved a rare chance from Levante when he palmed away a shot by Olivier Kapo from inside the 18-yard box three minutes after the interval.
Levante goalkeeper Jose Molina responded five minutes past the hour mark after he blocked a close-range effort by Raul.
Substitute Nieto, who was introduced instead of injured Robinho, should have leveled the score in the 75th minute when he was released inside the area by Raul's pass before smashing a powerful drive that cannoned off the bar.
Levante held on to their lead to secure a precious victory over the Spanish giants.
Earlier on Sunday, Sevilla wasted a chance to go on top of the table after they were held to a goalless draw by Real Sociedad.
Despite the draw, Sevilla are still second with 42 points.