The 21-year-old has signed a five-year contract with the Spanish giants.
Real Madrid wrote on their Twitter: “Real Madrid C.F. & Málaga C. F. have reached an agreement for the transfer of Isco who will play for the Whites for the next 5 seasons.”
New Manchester City boss Manuel Pellegrini was keen to bring the youngster to Eastlands.
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The reputation of the Premier League means it is the most popular and one of the most watched leagues in the world.
Five English clubs will compete in the last sixteen of the Champions League for the first time ever as Liverpool, Manchester United, Manchester City, Chelsea and Tottenham face some difficult away matches.