A finite element-based subspace fitting approach is proposed for the identification of vibrating structures. The approach makes use of the subspace-based state space system identification (4SID) methods which aim at assessing a so-called extended observability matrix from the knowledge of experimental measurement data. The feature of the present work concerns the use of a finite element model updating procedure to identify the structure parameters accurately when the number of output sensors is small. Besides, an algorithm procedure is proposed which, once combined with the finite element-based subspace fitting approach, provides an accurate and fast way to localize damages in structures. This involves an iterative domain partitioning scheme of a coarse finite element mesh, as well as a subdomain updating technique. The relevance of the proposed approaches is highlighted through the following test cases: (i) a numerical beam, based on a 3D finite element mesh, containing single or double notches; (ii) an experimental beam containing a single notch.