Virtual hosts in RabbitMQ allow creating separate environments for different clients or applications. The process starts by creating a virtual host using 'rabbitmqctl add_vhost'. Then, permissions are assigned to users for that virtual host with 'rabbitmqctl set_permissions'. Clients connect specifying the virtual host they want to use. Once connected, clients can only access resources inside their assigned virtual host. Attempts to access other virtual hosts fail due to permission restrictions. This isolation helps keep different applications or teams separated securely within the same RabbitMQ server.