Usual triggers for this reversion to .local domains are DNS server issues, or DNS referencing issues, or a failure to have the DNS servers in the DHCP information, or having disparate DNS servers referenced.
(10.6.3 slightly changed the rules around DNS server references when multiple servers are specified; the whole list is now tried, which is better and also worse than the older behavior.)
I just worked a case for a client after a 10.6.3 upgrade that involved apparent changes in the parsing rules and an incompatibility with an existing set of DNS configuration zone files (or a weirdness where Server Admin wasn't writing entirely valid DNS, I didn't revert and check that). That trigger was tracked down using the DNS server gonzo, err, debug diagnostics. That was also manifesting a domain change, but it was also showing slowdowns.
What does the following shell command report?
sudo changeip -checkhostname