"The variation in default rates by region is quite substantial. Default rates in the Northcentral states were about ve times as large as default rates in the Southeastern states. These dierences reﬂect the credit rate risk associated with the real estate markets in each of the regions, the fortunes of the regional economies, and the loan-to- value ratios and ages of the mortgages." - Quigley and Van Order (1991), p. 358, italics added "The pattern of covariances in these returns suggests that portfolio risk can be reduced by geographical diversication . . . " - Quigley and Van Order (1991), p. 361 Implicit in this argument is an assumption that the fundamentals that generate returns to housing are not perfectly correlated across space. However, if metropolitan areas are viewed as small open economies, they will share shocks to the prices of common inports and exports|shocks that may spill over to housing markets. This paper demonstrates that the correlation of returns to residential housing between two metropolitan areas is a function not only of their physical proximitiy but also the similarity of their indus- trial composition. This implies that as local economies evolve so will the covariance of housing returns|suggesting that the benets derived from diversication are maxi- mized by considering the industry risk inherent in the current metropolitan areas, not just the correlation of past returns.