Abstract This paper empirically investigates the impact of local house price booms on capital misallocation within manufacturing industries. Using the geographical variation provided by the salient Spanish housing boom (2003-2007), we show that manufacturing firms exposed to positive local house price shocks received more credit from banks and their investment grew more intensively when they had a larger proportion of collateralizable real estate assets. We exploit the geographical variation in both house prices and pre-boom urban land supply at the municipality level to document that this collateral channel was exacerbated for firms located in urban land-constrained areas where real estate appreciation was larger. The interaction of geographical conditions, that led to heterogeneous housing booms, with the collateral channel on investment resulted in an increasing dispersion of the capital-labor ratio within industries. A simple counterfactual calculation suggests that the capital misallocation generated by the collateral channel on investment could account for around 40% of the fall in TFP experienced by the Spanish economy during the housing boom.