I made a ISO of the update, mounted it as a drive and ran the setup with the VM running normally.
It worked well, although I did see one error message during the update that I didn't capture.
My VM has 2 threads of 1 real core allocated, and its 32bit Windows 10 Home.
Have you tried a newer virtio?
I used 113 recently to setup a 32bit Windows 10 VM (runs in 1.5GB ram), and a Server 2016 VM. Settings for Windows 10 attached if it helps.
Latest virtio-win iso: https://fedorapeople.org/groups/virt/virtio-win/direct-downloads/latest-virtio/virtio-win.iso
Also this post is helpful spelling out the steps to load the virtio drivers (if you need any tips):
https://lime-technology.com/forum/index.php?topic=41652.msg399892#msg399892
I have the server 2016 preview 4 running in an unRaid vm.
I used the virtio-win-0.1.113.iso virtio drivers - selecting 2012 R2.
Memory 2GB, i440fx-2.5, SeaBIOS, VNC driver QXL.
Works quite well. I followed the order of virtio driver installation from Step 5 here:
http://lime-technology.com/wiki/index.php/UnRAID_6/VM_Management#Step_5:_Install_the_VirtIO_drivers_from_inside_the_VM_.28Windows_Guests_Only.29