UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
                          -----------------                                
                                     OR         
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from               to 
                               -------------    -------------            
Commission file number 0-14350
                       -------
                     BALCOR REALTY INVESTORS 85-SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
            ------------------------------------------------------
            (Exact name of registrant as specified in its charter)

           Illinois                                      36-3333344
-------------------------------                      ------------------- 
(State or other jurisdiction of                       (I.R.S. Employer
incorporation or organization)                       Identification No.)

2355 Waukegan Rd.
Bannockburn, IL                                             60015
----------------------------------------             -------------------   
(Address of principal executive offices)                  (Zip Code)    

Registrant's telephone number, including area code (847) 267-1600
                                                   --------------
Securities registered pursuant to Section 12(b) of the Act:  None
                                                             ----
Securities registered pursuant to Section 12(g) of the Act:

                         Limited Partnership Interests
                         -----------------------------
                               (Title of class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ]  No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K [X]
<PAGE>
                                    PART I

Item 1. Business
----------------

Balcor Realty Investors 85-Series III A Real Estate Limited Partnership (the
"Registrant") is a limited partnership formed in 1984 under the laws of the
State of Illinois. The Registrant raised $59,087,000 from sales of Limited
Partnership Interests. The Registrant's operations consist exclusively of
investment in and operation of income-producing real property, and all
financial information included in this report relates to this industry segment.

The Registrant utilized the net offering proceeds to acquire eight real
property investments and a minority joint venture interest in one additional
real property. The Registrant has since disposed of six of these properties,
and the property in which the Registrant held a minority joint venture
interest. As of December 31, 1996, the Registrant owned the two properties
described under "Item 2. Properties." The Partnership Agreement generally
provides that the proceeds of any sale or refinancing of the Registrant's
properties will not be reinvested in new acquisitions.

The Registrant's remaining properties face various levels of competition for
retention of their tenants from similar types of properties in the vicinities
in which they are located. The Registrant has no plans to change the current
use of or to renovate any of its remaining properties. See "Item 7. Liquidity
and Capital Resources" for additional information.

Real estate values, especially for good quality, well located property,
increased significantly during 1996 due to a combination of readily available
capital, low interest rates, and decreased vacancy rates resulting from steady
demand and an acceptable level of new construction. While 1996 proved to be an
excellent year to sell real estate, projected yields by buyers on new
acquisitions have declined significantly due to competition and rising prices.
Although there will be variances by asset class and geographic area, the
investment climate is expected to remain strong for 1997. However, values could
begin to level off as they approach replacement cost, triggering new
construction and an increase in capitalization rates.

The investment market for apartments was excellent during 1996 due to a number
of factors. Investor interest was strong, driven primarily by institutions, as
Real Estate Investment Trusts aggressively expanded their portfolios and
pension funds viewed apartments as an attractive asset class due to their
perceived low volatility and the emergence of large professional management
companies. Operationally, existing apartment properties registered on a
national basis occupancy in the mid 90's and rental rates increases of 3-4% in
1996. While above the rate of inflation, the rate of rental growth in 1996 was
below that of the previous two years suggesting that the apartment cycle may
have plateaued, especially as the impact of new construction in many areas is
being felt. While 1997 is projected to be another solid year, values should
begin to level off as capitalization rates move upward continuing a trend which
began during the second half of 1996.
<PAGE>
During June, August and September 1996, the Registrant sold the Country Ridge,
Shadowridge and Park Place - Phase II apartment complexes in all cash sales for
$15,950,000, $12,600,000 and $12,125,000, respectively. In addition, in October
1996, the Lakeville Resort Apartments, in which the Registrant owned a minority
joint venture interest, was sold in an all cash sale for $27,200,000. See "Item
7. Liquidity and Capital Resources" for additional information. Currently, the
Registrant has entered into contracts to sell the Howell Station and North Hill
apartment complexes for sales prices of $10,000,000 and $22,750,000,
respectively.

The timing of the termination of the Registrant and final distribution of cash
will depend upon the nature and extent of liabilities and contingencies which
exist or may arise. Such contingencies may include legal and other fees
stemming from litigation involving the Registrant including, but not limited
to, the lawsuits discussed in "Item 3. Legal Proceedings." In the absence of
any contingency, the reserves will be paid within twelve months of the last
property being sold. In the event a contingency exists, reserves may be held by
the Registrant for a longer period of time.

Activity for the purchase of limited partnership interests ("tender offers")
has increased in real estate limited partnerships generally. Many of these
tender offers have been made by investors seeking to make a profit from the
purchase of the interests. In the event a tender offer is made for interests in
the Registrant, the General Partner will issue a response to limited partners
expressing the General Partner's opinion regarding the offer. Certain
administrative costs will be incurred to respond to a tender offer. The General
Partner cannot predict with any certainty what impact a tender offer will have
on the operations or management of the Registrant.

The Registrant, by virtue of its ownership of real estate is subject to federal
and state laws and regulations covering various environmental issues.
Management of the Registrant utilizes the services of environmental consultants
to assess a wide range of environmental issues and to conduct tests for
environmental contamination as appropriate.  The General Partner is not aware
of any potential liability due to environmental issues or conditions that would
be material to the Registrant.

The officers and employees of Balcor Partners-XVIII, the General Partner of the
Registrant, and its affiliates perform services for the Registrant. The
Registrant currently has no employees engaged in its operations.

Other Information
-----------------

Howell Station Apartments
-------------------------

As previously reported, the Registrant has contracted to sell the Howell
Station Apartments, Duluth, Georgia (the "Property"), for a sale price of
$9,000,000 to an unaffiliated party, Group One Investments, Inc., an Illinois
corporation. The Registrant also executed an agreement to sell to the purchaser
the personal property located at the Property for a sale price of $1,000,000.
Pursuant to an agreement between the Registrant and the purchaser, the closing
of the sale has been extended from April 4, 1997 to April 29, 1997.
<PAGE>
Item 2. Properties
------------------

As of December 31, 1996, the Registrant owns the two properties described
below:

Location                     Description of Property
--------                     -----------------------

Duluth, Georgia              Howell Station Apartments (formerly Tempo
                             Station): a 228-unit apartment complex located on
                             approximately 28.6 acres.

DeKalb County, Georgia     * North Hill Apartments: a 420-unit apartment
                             complex located on approximately 30 acres.

*  This property is owned by Registrant through a joint venture with an 
   affiliated partnership. See Note 7 of Notes to Financial Statements for   
   additional information.

Each of these properties is held subject to various forms of financing.

The average occupancy rates and the effective average rent per unit for each of
the last five years for the two properties owned by the Registrant at December
31, 1996 are described below:

                       1996        1995        1994        1993        1992   
                    ----------  ----------  ----------  ----------  ----------

Howell Station
  Occupancy rate        94%         95%         99%         98%         98%
  Effective rent       $700        $700        $680        $621        $588
 
North Hill
  Occupancy rate        92%         97%         96%         97%         96%
  Effective rent       $767        $755        $707        $676        $652

Apartment units in these properties are rented with leases of one year or less,
with no tenant occupying greater than ten percent of the property. Real estate
taxes incurred in 1996 for these properties totaled $469,866.

The Federal tax basis of the Registrant's properties totaled $31,469,425 as of
December 31, 1996. For Federal income tax purposes, the acquisition costs of
the properties are depreciated over useful lives ranging from 15 to 19 years,
using the ACRS method. Other minor assets are depreciated over their applicable
recovery periods.

In the opinion of the General Partner, the Registrant has provided for adequate
insurance coverage for its real estate investment properties.

See Notes to Financial Statements for other information regarding real property
investments.

Item 3. Legal Proceedings
-------------------------
<PAGE>
Proposed class action
---------------------

On February 29, 1996, a proposed class action complaint was filed, Raymond
Masri vs. Lehman Brothers, Inc., et al., Case No. 96/103727 (Supreme Court of
the State of New York, County of New York). The Registrant, additional limited
partnerships which were sponsored by The Balcor Company, three limited
partnerships sponsored by the predecessor of Lehman Brothers, Inc. (together
with the Registrant and the affiliated partnerships, the "Defendant
Partnerships"), Lehman Brothers, Inc. and Smith Barney Holdings, Inc. are
defendants. The complaint alleges, among other things, common law fraud and
deceit, negligent misrepresentation and breach of fiduciary duty relating to
the disclosure of information in the offering of limited partnership interests
in the Defendant Partnerships. The complaint seeks judgment for compensatory
damages equal to the amount invested in the Defendant Partnerships by the
proposed class plus interest accrued thereon; general damages for injuries
arising from the defendants' alleged actions; recovery from the defendants of
all profits received by them as a result of their alleged actions relating to
the Defendant Partnerships; exemplary damages; attorneys' fees and other costs.

The defendants intend to vigorously contest this action. No class has been
certified as of this date. The Registrant believes it has meritorious defenses
to contest the claims. It is not determinable at this time whether or not an
unfavorable decision in this action would have a material adverse impact on the
Registrant.

Proposed class action
---------------------

On August 30, 1996, a proposed class action complaint was filed, Lenore Klein
vs. Lehman Brothers, Inc., et al., Superior Court of New Jersey, Law Division,
Union County, Docket No. Unn-L-5162-96). The Registrant, additional limited
partnerships which were sponsored by The Balcor Company (together with the
Partnership, the "Affiliated Partnerships"), American Express Company, Lehman
Brothers, Inc., additional limited partnerships sponsored by the predecessor of
Lehman Brothers, Inc. (together with the Registrant and the Affiliated
Partnerships, the "Defendant Partnerships") and Smith Barney Holdings, Inc. are
the named defendants in the action. The complaint was amended on October 18,
1996 to add additional plaintiffs. The amended complaint alleges, among other
things, common law fraud and deceit, negligent misrepresentation, breach of
contract, breach of fiduciary duty and violation of certain New Jersey statutes
relating to the disclosure of information in the offering of limited
partnership interests in the Defendant Partnerships. The amended complaint
seeks judgment for compensatory damages equal to the amount invested in the
Defendant Partnerships by the proposed class plus interest; general damages for
injuries arising from the defendants' alleged actions; equitable relief,
including rescission, on certain counts; punitive damages; treble damages on
certain counts; recovery from the defendants of all profits received by them as
a result of their alleged actions relating to the Defendant Partnerships;
attorneys' fees and other costs.

The defendants intend to vigorously contest this action. No class has been
certified as of this date. The Registrant believes it has meritorious defenses
to contest the claims. It is not determinable at this time whether or not an
unfavorable decision in this action would have a material adverse impact on the
Registrant.
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
-----------------------------------------------------------

No matters were submitted to a vote of the Limited Partners of the Registrant
during 1996.
<PAGE>
                                    PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder
-------------------------------------------------------------------------
Matters
-------

There has not been an established public market for Limited Partnership
Interests and it is not anticipated that one will develop. For information
regarding distributions, See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."

As of December 31, 1996, the number of record holders of Limited Partnership
Interests of the Registrant was 4,665.

Item 6. Selected Financial Data
-------------------------------

                                      Year ended December 31,                 
                    ----------------------------------------------------------
                       1996        1995        1994        1993        1992   
                    ----------  ----------  ----------  ----------  ----------

Total income      $14,299,834  $12,057,899$11,089,861 $11,502,928   $12,511,661
Income (loss) 
  before 
  extraordinary
  items            23,182,758     (17,476)  (471,133) (1,079,762)   (2,009,380)
Net income (loss)  22,556,310     (27,411)   (70,139)   2,213,346   (2,009,380)
Net income (loss) 
  per Limited
  Partnership     
  Interest             377.90        (.46)     (1.18)       37.08       (33.66)
Total assets       27,755,377   45,259,656 46,571,333  47,232,370    59,876,925
Mortgage notes
  payable          24,324,028   50,428,070 50,987,329  51,850,501    65,816,872
Distributions per
  Limited Part-
  nership Interest (A) 230.00         7.50       None        None          None

(A) These amounts include distributions of original capital of $200.00 per
Limited Partnership Interest for 1996.

Item 7. Management's Discussion and Analysis of Financial Condition and
-----------------------------------------------------------------------
Results of Operations
---------------------

Operations
----------

Summary of Operations
---------------------
<PAGE>
During 1996, Balcor Realty Investors 85-Series III A Real Estate Limited
Partnership (the "Partnership") sold three properties. As a result of the gains
on the sales of these properties, as well as the increase in participation
income of joint venture with an affiliate resulting from the gain on the sale
of the Lakeville Apartments, the Partnership generated net income during 1996
as compared to a net loss during 1995. During 1995 the Partnership experienced
improved operations as a result of increased rental income at all of the
Partnership's properties. In addition, the Partnership recognized gains on
forgiveness of debt in 1995 and 1994. As a result, the Partnership recognized a
decrease in net loss during 1995 as compared to 1994. Further discussion of the
Partnership's operations is summarized below.

1996 Compared to 1995
---------------------

The Partnership sold the Country Ridge, Shadowridge and Park Place - Phase II
apartment complexes in June, August, and September 1996, respectively, which
resulted in a decrease of approximately $2,841,000 in rental and service income
during 1996 as compared to 1995. This decrease was partially offset by
increases of approximately $128,000 in rental and service income at the
Partnership's two remaining properties.

Due to higher average cash balances as a result of the investment of proceeds
from the sales of the Country Ridge, Shadowridge and Park Place - Phase II
apartment complexes prior to distribution to the Limited Partners, interest
income on short-term investments increased during 1996 as compared to 1995.

The Partnership owned a minority joint venture interest in the Lakeville Resort
Apartments. The Partnership recognized income from participation in joint
venture with an affiliate during 1996 as compared to a loss in 1995 primarily
due to the recognition of the Partnership's share of the gain on the 1996 sale
of the property. As a result of the June 1995 loan refinancing on the property,
the Partnership recognized extraordinary debt extinguishment expense of $58,521
in 1995.

As a result of the three sales in 1996 and the related pay-off of the
underlying mortgages, interest expense on mortgage notes payable decreased
during 1996 as compared to 1995. 

Depreciation expense decreased during 1996 as compared to 1995 due to the 1996
property sales. 

As a result of the 1996 property sales, property operating expense for 1996
decreased by approximately $880,000 when compared to 1995. Property operating
expense also decreased by approximately $161,000 due to exterior painting
expenditures during 1995 at North Hill Apartments. These decreases were
partially offset by higher payroll and utilities expenses of approximately
$89,000 at the Country Ridge, North Hill and Park Place - Phase II apartment
complexes.

Real estate tax expense for 1996 decreased approximately $158,000 when compared
to 1995 due to the 1996 property sales. This decrease was partially offset by
an approximately $13,000 increase in real estate tax expense at the Howell
Station apartments as a result of an increase in the assessed value of the
property.
<PAGE>
Property management fees decreased during 1996 compared to 1995 due to the
three property sales during 1996.

The Partnership incurred higher legal, consulting, printing, and postage costs
in connection with a response to a tender offer during the fourth quarter of
1995. As a result, administrative expense decreased during 1996 as compared to
1995. This decrease was partially offset by higher printing, postage and
investor servicing costs of approximately $28,000 incurred in connection with
the Partnership's response to a tender offer during 1996. 

For financial statement purposes, the Partnership recognized gains of
$19,528,414 during 1996 in connection with the sales of the Country Ridge,
Shadowridge and Park Place - Phase II apartment complexes.

The Shadowridge and North Hill apartment complexes are both owned by joint
ventures consisting of the Partnership and an affiliate. As a result of the
gain recognized in connection with the sale of Shadowridge Apartments in August
1996, affiliates' participation in income from joint ventures increased during
1996 as compared to 1995.

In connection with the 1996 property sales, the Partnership wrote off the
remaining unamortized deferred expenses in the amount of $440,081, and
recognized debt extinguishment expense, of which $7,165 represents the
Shadowridge Apartments minority joint venture partner's share.
 
In connection with a settlement reached with the seller of the Shadowridge
Apartments in 1995, the Partnership recognized an extraordinary gain on
forgiveness of debt of $69,409, of which $20,823 represented the affiliate's
share.

In connection with the sale of Lakeville Resort Apartments, the Partnership
recognized its share of the write off of the remaining unamortized deferred
expenses in the amount of $193,532. For financial statement purposes, this
amount was recognized as participation in debt extinguishment expense of joint
venture with an affiliate.

1995 Compared to 1994
---------------------

Rental and service income increased during 1995 as compared to 1994 as a result
of higher average rental rates and stable occupancy at each of the
Partnership's remaining properties.

During December 1994, the North Hill Apartments mortgage loan was refinanced
and the remaining deferred expenses relating to the previous mortgage loan were
fully amortized. As a result, amortization expense decreased during 1995 as
compared to 1994.

As a result of exterior painting costs at the Country Ridge, North Hill and
Shadowridge apartment complexes and costs related to structural repairs at
Shadowridge Apartments, property operating expense increased during 1995 as
compared to 1994.
<PAGE>
Real estate tax expense decreased during 1995 as compared to 1994 by
approximately $82,200 as a result of lower tax rates at the Country Ridge and
Park Place - Phase II apartment complexes.  An increase in the assessed value
at the North Hill Apartments partially offset this decrease by approximately
$26,500.

The Partnership incurred higher legal, consulting, printing and postage costs
in connection with a tender offer during the fourth quarter of 1995. As a
result, administrative expenses increased during 1995 as compared to 1994.

The Partnership held a minority interest in the Lakeville Resort Apartments.
The loss from joint venture with an affiliate decreased during 1995 as compared
to 1994 due to improved property operations of approximately $605,000, which
was partially offset by higher interest expense of approximately $195,000. In
June 1995, the mortgage note was refinanced with a new lender. In connection
with this transaction, the Partnership recognized an extraordinary debt
extinguishment expense of $58,521.

The Shadowridge and North Hill apartment complexes, are both owned by joint
ventures consisting of the Partnership and an affiliate. As a result of
increased exterior painting costs at both properties, affiliates' participation
in loss from joint venture increased in 1995 as compared to 1994.

In connection with the December 1994 North Hill Apartments' mortgage loan
refinancing, the joint venture received a refund of the escrow account held by
the trustee representing the amount which would have been paid to Mutual
Benefit Life Insurance Company as its 1% guarantee fee on the original North
Hill Apartments' mortgage loan. As a result, the Partnership recognized a
$534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665
represents the affiliate's share.

Liquidity and Capital Resources
-------------------------------

The cash position of the Partnership as of December 31, 1996, increased by
approximately $3,577,000 when compared to December 31, 1995, primarily due to
proceeds received from the sale of Lakeville Resort Apartments. Cash flow of
approximately $1,626,000 was provided by operating activities consisting of
cash flow from the operations of the Partnership's properties and interest
income on short-term investments, which were partially offset by the payment of
administrative expenses. Cash provided by investing activities consists
primarily of proceeds of approximately $33,212,000 from the sales of the
Country Ridge, Shadowridge and Park Place - Phase II apartment complexes, as
well as the Partnership's share of proceeds from the sale of Lakeville Resort  
apartments. Net cash used in financing activities consists primarily of
activities resulting from the 1996 property sales, including distributions of
$11,818,000 of sales proceeds to Limited Partners, repayment of mortgage loans
payable totaling approximately $16,732,000 on the Country Ridge and Shadowridge
apartment complexes, and the release of capital improvement escrow funds
totaling $468,000 upon the sale of the Park Place - Phase II apartments. In
addition, the Partnership made a special distribution to the Limited Partners
in January 1997 from proceeds received in connection with the sale of the
Lakeville Resort Apartments and the release of Country Ridge and Park Place -
Phase II apartment complexes holdbacks. 
<PAGE>
The Partnership classifies the cash flow performance of its properties as
either positive, a marginal deficit or a significant deficit, each after
consideration of debt service payments unless otherwise indicated. A deficit is
considered to be significant if it exceeds $250,000 annually or 20% of the
property's rental and service income. The Partnership defines cash flow
generated from its properties as an amount equal to the property's revenue
receipts less property related expenditures, which include debt service
payments. During 1996 and 1995, the Partnership's two remaining properties
generated positive cash flow. Shadowridge Apartments generated positive cash
flow prior to its sale in August 1996, and a marginal cash flow deficit during
1995. The Country Ridge and Park Place - Phase II apartment complexes generated
positive cash flow in 1995 and prior to their sales in 1996. In addition,
Lakeville Resort Apartments, in which the Partnership held a minority joint
venture interest, generated positive cash flow in 1996 prior to its sale and in
1995. As of December 31, 1996, the occupancy rates of Howell Station and North
Hill apartment complexes were 94% and 92%, respectively.

North Hill is located in an area of Atlanta, Georgia, known as Chamblee. This
area has a diverse apartment market that caters to a wide range of apartment
dwellers. North Hill competes with the higher-end product in this sub-market.
Average occupancy in 1996 was 96% for similar properties in the area.
Approximately 25,000 new multi-family units were added to Atlanta's apartment
inventory during 1995 and 1996. While this heavy supply of new product is being
absorbed by apartment dwellers due to Atlanta's continued rapid growth in
population and employment, growth in rental rates has slowed significantly.

Howell Station is located in Duluth, Georgia, a northeast suburb of Atlanta
(Gwinnett County).  Duluth caters to the higher priced apartment dweller as it
offers mostly upper-end product. Howell Station's pricing falls within the
mid-range of this sub-market. Average occupancy in 1996 was 95% for similar
properties in the area. Approximately 25,000 new multi-family units were added
to Atlanta's apartment inventory during 1995 and 1996. While this heavy supply
of new product is being absorbed by apartment dwellers due to Atlanta's
continued rapid growth in population and employment, growth in rental rates has
slowed significantly.

As described below, the Partnership sold the Country Ridge and Park Place -
Phase II apartment complexes in June and September 1996, respectively.
Additionally, the Partnership and its joint venture affiliates sold the
Shadowridge and Lakeville Resort apartment complexes in August and October
1996, respectively. The North Hill and Howell Station apartment complexes are
currently under contract for sales prices of $22,750,000 and $10,000,000,
respectively, both of which are expected to close in April 1997.

The timing of the termination of the Partnership and final distribution of cash
will depend upon the nature and extent of liabilities and contingencies which
exist or may arise. Such contingencies may include legal and other fees
stemming from litigation involving the Partnership including, but not limited
to, the lawsuits discussed in "Item 3. Legal Proceedings." In the absence of
any such contingency, the reserves will be paid within twelve months of the
last property being sold. In the event a contingency arises, reserves may be
held by the Partnership for a longer period of time.
<PAGE>
In June 1996, the Partnership sold Country Ridge Apartments in an all cash sale
for $15,950,000. From the proceeds of the sale, the Partnership paid $8,770,310
to the third party mortgage holder in full satisfaction of the first mortgage
loan, and paid $134,625 in selling costs. Pursuant to the terms of the sale,
the Partnership was required to withhold distribution of $500,000 of the
proceeds to Partners until October 1996. The remainder of the proceeds were
distributed to the Limited Partners in July 1996. The full amount of the
holdback was released in October 1996. See Note 11 of Notes to Financial
Statements for additional information. 

The Shadowridge Apartments was owned by a joint venture consisting of the
Partnership and an affiliate. In August 1996, the joint venture sold the
property in an all cash sale for $12,600,000. From the proceeds of the sale,
the joint venture paid $7,961,627 to the third party mortgage holder in full
satisfaction of the first mortgage loan, and paid $384,545 in selling costs.
The net proceeds of the sale were $4,253,828 of which $2,977,680 was the
Partnership's share. The proceeds were distributed to the Limited Partners in
October 1996. See Note 11 of Notes to Financial Statements for additional
information.

In September 1996, the Partnership sold the Park Place Apartments - Phase II in
an all cash sale for $12,125,000. The purchaser of the property took title
subject to the existing first mortgage loan in the amount of $8,996,012. From
the proceeds of the sale, the Partnership paid $181,719 in selling costs.
Pursuant to the terms of the sale, $500,000 of the proceeds were retained by
the Partnership until December 1996. The remainder of the proceeds were
distributed to the Limited Partners in October 1996.  The full amount of the
holdback was released in December 1996.  See Note 11 of Notes to Financial
Statements for additional information.

The Lakeville Resort Apartments was owned by a joint venture consisting of the
Partnership and an affiliate. In October 1996, the joint venture sold the
property in an all cash sale for $27,200,000. The purchaser took title subject
to the existing first mortgage loan in the amount of $20,795,872. From the
proceeds of the sale, the joint venture paid $355,000 in selling costs. The net
proceeds of the sale were approximately $6,049,000, of which approximately
$2,435,000 was the Partnership's share. Pursuant to the terms of the sale,
$500,000 of the proceeds were retained by the joint venture until February
1997. The full amount of the holdback was released in February 1997. The
remainder of the proceeds were distributed to the Limited Partners in January
1997. See Note 8 of Notes to Financial Statements for additional information. 

The Partnership's remaining two properties are owned through the use of third
party mortgage loan financing and, therefore, the Partnership is subject to the
financial obligations required by such loans. The Partnership does not own any
properties with third-party financing which matures prior to 2001.

In January 1997, the Partnership made a distribution of $4,402,354 ($74.50 per
Interest) to the holders of Limited Partnership Interests for the fourth
quarter of 1996. The regular quarterly Net Cash Receipts distribution of
$443,190 ($7.50 per Interest) remained unchanged from the amount distributed
since commencement of distributions in the fourth quarter of 1995. In addition,
Net Cash Proceeds of $3,959,164 ($67.00 per Interest) were distributed to the
Limited Partners from proceeds received in connection with the sale of the
Lakeville Resort Apartments and the release of Country Ridge and Park Place -
Phase II apartment complexes holdbacks. Including the January 1997
distribution, Limited Partners have received cumulative distributions of Net
<PAGE>
Cash Receipts of $45.00 per $1,000 Interest, and Net Cash Proceeds of $267.00
per $1,000 Interest totaling $312.00 per $1,000 Interest. Future distributions
will be made from available cash flow as well as proceeds from the sale of the
remaining properties, as to which there can be no assurances. In light of
results to date, investors will not recover all of their original investment. 

Inflation has several types of potentially conflicting impacts on real estate
investments. Short-term inflation can increase real estate operating costs
which may or may not be recovered through increased rents and/or sales prices,
depending on general or local economic conditions. In the long-term, inflation
can be expected to increase operating costs and replacement costs and may lead
to increased rental revenues and real estate values.

Certain statements in this Form 10-K constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. These
statements may include projections of revenues, income or losses, capital
expenditures, plans for future operations, financing plans or requirements, and
plans relating to properties of the Partnership, as well as assumptions
relating to the foregoing.

The forward-looking statements made by the Partnership are subject to known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Partnership to differ materially
from any future results, performance or achievements expressed or implied by
the forward-looking statements.

Item 8. Financial Statements and Supplementary Data
---------------------------------------------------

See Index to Financial Statements and Financial Statement Schedule in this
Form 10-K.

The supplemental financial information specified by Item 302 of Regulation S-K
is not applicable.

The net effect of the differences between the financial statements and the tax
returns is summarized as follows:

                         December 31, 1996         December 31, 1995    
                      -----------------------  -------------------------
                      Financial        Tax       Financial        Tax
                      Statements     Returns    Statements      Returns 
                      ----------    ---------   ----------     ---------

Total assets        $27,755,377   $24,816,587  $45,259,656   $33,253,424
Partners' Capital
  (deficit)
  accounts:
    General Partner    (348,962)     (469,072)    (574,525)     (846,053)
    Limited Partners  3,995,822     3,744,858   (4,743,765)  (15,632,680)
Net income (loss):
    General Partner     225,563       376,981         (274)       (7,861)
    Limited Partners 22,330,747    32,968,698      (27,137)     (778,016)
    Per Limited Part-
      nership Interest   377.90        557.92         (.46)       (13.17)
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
-----------------------------------------------------------------------
Financial Disclosure
--------------------

There have been no changes in or disagreements with accountants on any matter
of accounting principles, practices or financial statement disclosure.

                                   PART III

Item 10. Directors and Executive Officers of the Registrant
-----------------------------------------------------------

(a) Neither the Registrant nor Balcor Partners-XVIII, its General Partner, has
a Board of Directors.

(b, c & e) The names, ages and business experience of the executive officers
and significant employees of the General Partner of the Registrant are as
follows:


               TITLE                              OFFICERS
               -----                              --------
         Chairman, President and Chief         Thomas E. Meador
            Executive Officer
         Senior Vice President                 Alexander J. Darragh
         Senior Vice President                 James E. Mendelson
         Senior Vice President                 John K. Powell, Jr.
         Managing Director, Chief              Jayne A. Kosik
            Financial Officer, Treasurer
            and Assistant Secretary                            


Thomas E. Meador (age 49) joined Balcor in July 1979. He is Chairman,
President and Chief Executive Officer and has responsibility for all ongoing
day-to-day activities at Balcor. He is a Director of The Balcor Company. He
is also Senior Vice President of American Express Company and is responsible
for its real estate operations worldwide. Prior to joining Balcor, Mr. Meador
was employed at the Harris Trust and Savings Bank in the commercial real
estate division where he was involved in various lending activities. Mr.
Meador received his M.B.A. degree from the Indiana University Graduate School
of Business.

Alexander J. Darragh (age 42) joined Balcor in September 1988 and is
responsible for due diligence analysis and real estate advisory services for
Balcor and American Express Company. He also has supervisory responsibility
for Balcor's environmental matters. Mr. Darragh received masters' degrees in
Urban Geography from Queen's University and in Urban Planning from
Northwestern University.
<PAGE>
James E. Mendelson (age 34) joined Balcor in July 1984 and is responsible for
Balcor's property sales activities. He also has supervisory responsibility
for Balcor's accounting, financial, treasury, investor services and
investment administration functions. From 1989 to 1995, Mr. Mendelson was
Vice President - Transaction Management and Vice President - Senior
Transaction Manager and had responsibility for various asset management
matters relating to real estate investments made by Balcor, including
negotiations for the restructuring of mortgage loan investments. Mr.
Mendelson received his M.B.A. degree from the University of Chicago. 

John K. Powell, Jr. (age 46) joined Balcor in September 1985 and is
responsible for portfolio and asset management matters relating to Balcor's
partnerships. Mr. Powell also has supervisory responsibility for Balcor's
risk management function. He received a Master of Planning degree from the
University of Virginia. Mr. Powell has been designated a Certified Real
Estate Financier by the National Society for Real Estate Finance and is a
full member of the Urban Land Institute.

Jayne A. Kosik (age 39) joined Balcor in August 1982 and, as Chief Financial
Officer, is responsible for Balcor's financial, human resources and treasury
functions. From June 1989 until October 1996, Ms. Kosik had supervisory
responsibility for accounting functions relating to Balcor's public and
private partnerships. She is also Treasurer and a Managing Director of The
Balcor Company. Ms. Kosik is a Certified Public Accountant.  


(d) There is no family relationship between any of the foregoing officers.

(f) None of the foregoing officers or employees are currently involved in any
material legal proceedings nor were any such proceedings terminated during the
fourth quarter of 1996.

Item 11. Executive Compensation
-------------------------------

The Registrant paid $2,595 in 1996 with respect to one of the executive
officers and directors of Balcor Partners - XVIII, the General Partner. Certain
of these officers receive compensation from The Balcor Company (but not from
the Registrant) for services performed for various affiliated entities, which
may include services performed for the Registrant. The Registrant has not paid
and does not propose to pay any remuneration to the remaining executive
officers and directors of the General Partners. However, the General Partner
believes that any such compensation attributable to services performed for the
Registrant is immaterial to the Registrant. See Note 10 of Notes to Financial
Statements for the information relating to transactions with affiliates.

Item 12. Security Ownership of Certain Beneficial Owners and Management
-----------------------------------------------------------------------

(a)  The following entities are the sole Limited Partners which own
beneficially more than 5% of the outstanding Limited Partnership Interests of
the Registrant:
<PAGE>
                    Name and            Amount and
                    Address of          Nature of      Percent 
                    Beneficial          Beneficial     of
Title of Class      Owner               Ownership      Class
---------------     -----------       ------------    ------------

Limited             WIG 85-III          3,456.50       5.79%
Partnership         Partners            Limited
Interests           Chicago,            Partnership
                    Illinois            Interests

Limited             Metropolitan        2,567.00       4.30%
Partnership         Acquisition VII,    Limited
Interests           L.L.C. Greenville,  Partnership
                    South Carolina      Interests

While Metropolitan Acquisition VII, L.L.C. individually owns less than 5% of
the Interests, for purposes of this Item 12, Metropolitan Acquisition VII,
L.L.C. is an affiliate of WIG 85-III Partners and, collectively, they own
10.09% of the Interests.

(b) Balcor Partners-XVIII and its officers and partners own as a group the
following Limited Partnership Interests of the Registrant:

                                  Amount
                               Beneficially
         Title of Class            Owned       Percent of Class
         --------------        -------------   ----------------
         Limited Partnership
           Interests          1,180 Interests    Less than 2%


Relatives and affiliates of the officers and partners of the General Partner
own an additional 35 Interests.

Item 13. Certain Relationships and Related Transactions
-------------------------------------------------------

(a & b) See Note 4 of Notes to Financial Statements for information relating to
the Partnership Agreement and the allocation of distributions and profits and
losses.

See Note 10 of Notes to Financial Statements for additional information
relating to transactions with affiliates.

(c) No management person is indebted to the Registrant.

(d) The Registrant has no outstanding agreements with any promoters.
<PAGE>
                                    PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
------------------------------------------------------------------------

(a)
(1 & 2) See Index to Financial Statements and Financial Statement Schedule in
this Form 10-K.

(3) Exhibits:

(3) The Amended and Restated Agreement and Certificate of Limited Partnership,
set fourth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration
Statement on Form S-11 dated August 2,1985 (Registration No. 2-97249), is
incorporated herein by reference.

(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 1
to the Registrant's Registration Statement on Form S-11 dated August 2, 1985
(Registration No. 2-97249), and Form of Confirmation regarding Interests in the
Partnership set forth as Exhibit 4.2 to the Registrant's Report on Form 10-Q
for the quarter ended June 30, 1992 are incorporated herein by reference.

(10) Material Contracts:

(a)(i) Agreement of Sale and attachment thereto relating to the sale of Country
Ridge Apartments previously filed as Exhibit (2)(a) to the Registrant's Current
Report on Form 8-K dated April 23, 1996, is incorporated herein by reference.

(a)(ii) Master Amendment and Agreement dated May 22, 1996 relating to the sale
of Country Ridge Apartments previously filed as Exhibit (99)(a) to the
Registrant's Current Report on Form 8-K dated July 5, 1996, is incorporated
herein by reference.

(a)(iii) Master Amendment and Agreement #2 dated May 22, 1996 relating to the
sale of Country Ridge Apartments previously filed as Exhibit (99)(b) to the
Registrant's Current Report on Form 8-K dated July 5, 1996, is incorporated
herein by reference.

(b)(i) Agreement of Sale and attachment thereto relating to the sale of
Lakeville Resort Apartments previously filed as Exhibit (2)(b) to the
Registrant's Current Report on Form 8-K dated April 23, 1996, is incorporated
herein by reference.

(b)(ii) Letter Agreements dated May 22, 1996 and July 8, 1996 relating to the
sale of Lakeville Resort Apartments previously filed as Exhibit (99)(c) to the
Registrant's Current Report on Form 8-K dated July 5, 1996, is incorporated
herein by reference.

(b)(iii) Letter Agreement dated August 20, 1996 relating to the sale of
Lakeville Resort Apartments previously filed as Exhibit (99)(a) to the
Registrant's Current Report on Form 8-K dated August 20, 1996 is incorporated
herein by reference.

(b)(iv) Letter Agreement dated September 19, 1996 relating to the sale of
Lakeville Resort Apartments previously filed as Exhibit (10)(b)(iv) to the
Registrant's Report on Form 10-Q for the quarter ended September 30, 1996 is
incorporated herein by reference.
<PAGE>
(b)(v) Letter Agreement dated September 30, 1996 relating to the sale of
Lakeville Resort Apartments previously filed as Exhibit (10)(b)(v) to the
Registrant's Report on Form 10-Q for the quarter ended September 30, 1996 is
incorporated herein by reference.

(c)(i) Agreement of Sale and attachment thereto relating to the sale of Park
Place Apartments - Phase II previously filed as Exhibit (2)(c) to the
Registrant's Current Report on Form 8-K dated April 23, 1996, is incorporated
herein by reference.

(c)(ii) Letter Agreements dated May 22, 1996 and July 8, 1996 relating to the
sale of Park Place Apartments - Phase II previously filed as Exhibit (99)(d) to
the Registrant's Current Report on Form 8-K dated July 5, 1996, is incorporated
herein by reference.

(c)(iii) First Amendment to Agreement of Sale relating to the sale of Park
Place Apartments - Phase II previously filed as Exhibit (10)(c)(iii) to the
Registrant's Report on Form 10-Q for the quarter ended September 30, 1996 is
incorporated herein by reference.

(d)(i) Agreement of Sale and attachment thereto relating to the sale of
Shadowridge Apartments previously filed as Exhibit (2)(a) to the Registrant's
Current Report on Form 8-K dated July 5, 1996, is incorporated herein by
reference.

(d)(ii) First Amendment to Agreement of Sale and Escrow Agreement relating to
the sale of Shadowridge Apartments previously filed as Exhibit (99) to the
Registrant's Report on Form 10-Q dated June 30, 1996 is incorporated herein by
reference.

(e)(i) Agreement of Sale relating to the sale of North Hill Apartments
previously filed as Exhibit (2)(a)(i) to the Registrant's Current Report on
Form 8-K dated February 21, 1997 is incorporated herein by reference.

(e)(ii) Due Diligence Termination Notice relating to the sale of North Hill
Apartments previously filed as Exhibit (2)(a)(ii) to the Registrant's Current
Report on Form 8-K dated February 21, 1997 is incorporated herein by reference.

(e)(iii) Reinstatement of, and First Amendment to, the Agreement of Sale and
Escrow Agreement relating to the sale of North Hill Apartments previously filed
as Exhibit (2)(a)(iii) to the Registrant's Current Report on Form 8-K dated
February 21, 1997 is incorporated herein by reference.

(e)(iv) Second Amendment to Agreement of Sale and Escrow Agreement relating to
the sale of North Hill Apartments is attached hereto.

(f)(i) Agreement of Sale relating to the sale of Howell Station Apartments
previously filed as Exhibit (2)(b)(i) to the Registrant's Current Report on
Form 8-K dated February 21, 1997 is incorporated herein by reference.

(f)(ii) Amendment No. 1 relating to the sale of Howell Station Apartments
previously filed as Exhibit (2)(b)(ii) to the Registrant's Current Report on
Form 8-K dated February 21, 1997 is incorporated herein by reference.
<PAGE>
(f)(iii) Agreement relating to the sale of Howell Station Apartments previously
filed as Exhibit (2)(b)(iii) to the Registrant's Current Report on Form 8-K
dated February 21, 1997 is incorporated herein by reference.

(f)(iv) Amendment No. 2 to Agreement of Sale relating to the sale of Howell
Station Apartments previously filed as Exhibit (2)(b)(iv) to the Registrant's
Current Report on Form 8-K dated February 21, 1997 is incorporated herein by
reference.

(f)(v) Amendment No. 3 to Agreement of Sale relating to the sale of Howell
Station Apartments is attached hereto.

(27) Financial Data Schedule of the Registrant for 1995 is attached hereto.

(b) Reports on Form 8-K: No reports were filed on Form 8-K during the quarter
ended December 31, 1996.

(c) Exhibits: See Item 14(a)(3) above.

(d) Financial Statement Schedules: See Index to Financial Statements and
Financial Statement Schedule attached to this Form 10-K.
<PAGE>
SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                         BALCOR REALTY INVESTORS 85-SERIES III
                           A REAL ESTATE LIMITED PARTNERSHIP


                         By: /s/Jayne A. Kosik
                             ---------------------------------
                             Jayne A. Kosik
                             Managing Director and Chief 
                             Financial Officer (Principal
                             Accounting Officer)
                             of Balcor Partners-XVIII, the 
                             General Partner

Date: March 27, 1997
      --------------

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


       Signature                     Title                       Date    
----------------------  -------------------------------     --------------
                         President and Chief Executive
                         Officer (Principal Executive
                         Officer) of Balcor Partners-XVIII,
/s/Thomas E. Meador      the General Partner                March 27, 1997
---------------------                                       --------------
  Thomas E. Meador

                         Managing Director and Chief
                         Financial Officer (Principal 
                         Accounting Officer) of 
                         Balcor Partners-XVIII,
 /s/Jayne A. Kosik       the General Partner                March 27, 1997
--------------------                                        --------------
   Jayne A. Kosik
<PAGE>
        INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE



Report of Independent Accountants

Financial Statements:

Balance Sheets, December 31, 1996 and 1995

Statements of Partners' Capital (Deficit), for the years ended December 31,
1996, 1995 and 1994

Statements of Income and Expenses, for the years ended December 31, 1996, 1995
and 1994

Statements of Cash Flows, for the years ended December 31, 1996, 1995 and 1994

Notes to Financial Statements

Financial Statement Schedule:

III - Real Estate and Accumulated Depreciation, as of December 31, 1996


Financial Statement Schedules, other than that listed, are omitted for the
reason that they are inapplicable or equivalent information has been included
elsewhere herein. Audited Financial Statements for significant subsidiary
investment in joint venture are omitted since the property was sold and the
Partnership is in its liquidation phase.
<PAGE>
                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Partners of
Balcor Realty Investors 85-Series III

We have audited the financial statements and the financial statement schedule
of Balcor Realty Investors 85-Series III A Real Estate Limited Partnership (An
Illinois Limited Partnership) as listed in the Index of this Form 10-K. These
financial statements and financial statement schedule are the responsibility of
the Partnership's management. Our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Balcor Realty Investors
85-Series III at December 31, 1996 and 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1996, in conformity with generally accepted accounting principles. In addition,
in our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included herein.

As described in Note 2 to the financial statements, the partnership agreement
provides for the dissolution of the Partnership upon the disposition of all its
real estate interests. The Partnership is presently marketing for sale its
remaining real estate assets. Upon disposition of its remaining real estate
assets and resolution of the litigation described in Note 14 to the financial
statements, the Partnership intends to cease operations and dissolve.


                                   /s/Coopers & Lybrand L.L.P.

                                   COOPERS & LYBRAND L.L.P.



Chicago, Illinois
March 26, 1997
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                                BALANCE SHEETS
                          December 31, 1996 and 1995

                                    ASSETS

                                                  1996           1995
                                             -------------  --------------
Cash and cash equivalents                    $   5,888,040  $    2,310,596
Escrow deposits                                    696,354       1,400,287
Accounts and accrued interest receivable            93,191          89,717
Prepaid expenses                                    59,888         361,640
Deferred expenses, net of accumulated
  amortization of $250,656 in 1996 and
  $362,375 in 1995                                 781,323       1,227,709
Investment in joint venture with an affiliate    1,046,660      (1,139,760)
                                             -------------  --------------
                                                 8,565,456       4,250,189
                                             -------------  --------------
Investment in real estate:
  Land                                           3,161,992       6,536,422
  Buildings and improvements                    27,767,583      56,884,371
                                             -------------  --------------
                                                30,929,575      63,420,793
  Less accumulated depreciation                 11,739,654      22,411,326
                                             -------------  --------------
Investment in real estate, net of
  accumulated depreciation                      19,189,921      41,009,467
                                             -------------  --------------
                                             $  27,755,377   $  45,259,656
                                             =============  ==============

                  LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)

Accounts payable                             $      39,006   $      96,080
Due to affiliates                                   85,504          19,310
Security deposits                                  159,650         334,467
Mortgage notes payable                          24,324,028      50,428,070
                                             -------------  --------------
    Total liabilities                           24,608,188      50,877,927

Affiliates' participation in joint ventures       (499,671)       (299,981)
                                             -------------  --------------
                                                24,108,517      50,577,946
Commitments and contingencies
Limited Partners' capital (deficit) (59,092 
  Limited Partnership Interests issued
  and outstanding)                               3,995,822      (4,743,765)
General Partner's deficit                         (348,962)       (574,525)
                                             -------------  --------------
    Total partners' capital (deficit)            3,646,860      (5,318,290)
                                             -------------  --------------
                                             $  27,755,377   $  45,259,656
                                             =============  ==============

The accompanying notes are an integral part of the financial statements.
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                   STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
             for the years ended December 31, 1996, 1995 and 1994





                                     Partners' Capital (Deficit) Accounts
                                  --------------------------------------------
                                                     General        Limited
                                       Total         Partner        Partners
                                  -------------- -------------- --------------

Balance at December 31, 1993      $  (4,777,550) $    (573,550) $  (4,204,000)

Net loss for the year
  ended December 31, 1994               (70,139)          (701)       (69,438)
                                  -------------- -------------- --------------
Balance at December 31, 1994         (4,847,689)      (574,251)    (4,273,438)

Cash distributions to Limited 
  Partners (A)                         (443,190)                     (443,190)
Net loss for the year
  ended December 31, 1995               (27,411)          (274)       (27,137)
                                  -------------- -------------- --------------
Balance at December 31, 1995         (5,318,290)      (574,525)    (4,743,765)

Cash distributions to Limited
  Partners  (A)                     (13,591,160)                  (13,591,160)
Net income for the year
  ended December 31, 1996            22,556,310        225,563     22,330,747
                                  -------------- -------------- --------------
Balance at December 31, 1996      $   3,646,860  $    (348,962) $   3,995,822
                                  ============== ============== ==============



(A) Summary of cash distributions paid per Limited Partnership Interest:

                                        1996           1995

          First Quarter                $7.50           None

          Second Quarter                7.50           None

          Third Quarter               122.50           None

          Fourth Quarter               92.50          $7.50


The accompanying notes are an integral part of the financial statements.
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                       STATEMENTS OF INCOME AND EXPENSES
             for the years ended December 31, 1996, 1995 and 1994

                                       1996           1995           1994
                                  -------------- -------------- --------------
Income:
  Rental and service              $   9,176,157  $  11,889,557  $  11,036,707
  Interest on short-term
    investments                         248,586        170,938        157,773
  Participation in income (loss)
    of joint venture with an 
    affiliate                         4,875,091         (2,596)      (104,619)
                                  -------------- -------------- --------------
    Total income                     14,299,834     12,057,899     11,089,861
                                  -------------- -------------- --------------
Expenses:
  Interest on mortgage
    notes payable                     3,306,963      4,259,221      4,099,437
  Depreciation                        1,373,849      1,747,385      1,747,384
  Amortization of deferred
    expenses                            131,305        141,321        210,353
  Property operating                  2,946,970      3,859,285      3,421,828
  Real estate taxes                     884,257      1,028,753      1,136,617
  Property management fees              466,268        593,254        550,710
  Administrative                        391,560        515,975        410,825
                                  -------------- -------------- --------------
    Total expenses                    9,501,172     12,145,194     11,577,154
                                  -------------- -------------- --------------
Income (loss) before gain on 
  sales, affiliates' 
  participation in joint 
  ventures and extraordinary
  items                               4,798,662        (87,295)      (487,293)
Gain on sales of properties          19,528,414
Affiliates' participation in
  (income) loss from joint ventures
  before extraordinary items         (1,144,318)        69,819         16,160
                                  -------------- -------------- --------------
Income (loss) before extraordinary
  items                              23,182,758        (17,476)      (471,133)
                                  -------------- -------------- --------------
Extraordinary items:
  Debt extinguishment expense          (440,081)
  Affiliate's participation in 
    debt extinguishment expense           7,165
  Gain on forgiveness of debt                           69,409        534,659
  Affiliate's participation in
    gain on forgiveness of debt                        (20,823)      (133,665)
  Participation in debt 
    extinguishment expense of 
    joint venture with an 
    affiliate                          (193,532)       (58,521)
                                  -------------- -------------- --------------
Total extraordinary items              (626,448)        (9,935)       400,994
                                  -------------- -------------- --------------
Net income (loss)                 $  22,556,310  $     (27,411) $     (70,139)
                                  ============== ============== ==============

The accompanying notes are an integral part of the financial statements.
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                       STATEMENTS OF INCOME AND EXPENSES
             for the years ended December 31, 1996, 1995 and 1994
                                  (Continued)


                                       1996           1995           1994
                                  -------------- -------------- --------------
Income (loss) before 
  extraordinary items allocated  
  to General Partner              $     231,827  $        (175) $      (4,711)
                                  ============== ============== ==============
Income (loss) before 
  extraordinary items allocated 
  to Limited Partners             $  22,950,931  $     (17,301) $    (466,422)
                                  ============== ============== ==============
Income (loss) before 
  extraordinary items per  
  Limited Partnership Interest 
  (59,092 issued and outstanding) $      388.39  $       (0.29) $       (7.90)
                                  ============== ============== ==============
Extraordinary items allocated
  to General Partner              $      (6,264) $         (99) $       4,010
                                  ============== ============== ==============
Extraordinary items allocated
  to Limited Partners             $    (620,184) $      (9,836) $     396,984
                                  ============== ============== ==============
Extraordinary items per Limited
  Partnership Interest (59,092
  issued and outstanding)         $      (10.50) $       (0.17) $        6.72
                                  ============== ============== ==============
Net income (loss) allocated to
  General Partner                 $     225,563  $        (274) $        (701)
                                  ============== ============== ==============
Net income (loss) allocated to 
  Limited Partners                $  22,330,747  $     (27,137) $     (69,438)
                                  ============== ============== ==============
Net income (loss) per Limited
  Partnership Interest (59,092
  issued and outstanding)         $      377.90  $       (0.46) $       (1.18)
                                  ============== ============== ==============

The accompanying notes are an integral part of the financial statements.
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                           STATEMENTS OF CASH FLOWS
             for the years ended December 31, 1996, 1995 and 1994

                                       1996           1995           1994
                                  -------------- -------------- --------------
Operating activities:
  Net income (loss)               $  22,556,310  $     (27,411) $     (70,139)
  Adjustments to reconcile net
    income (loss) to net cash 
    provided by operating 
    activities:
      Gain on sales of properties   (19,528,414)
      Debt extinguishment expense       440,081
      Gain on forgiveness of 
        debt                                           (69,409)      (534,659)
      Release of escrow deposits                                      534,659
      Affiliate's participation 
        in debt extinguishment
        expense                          (7,165)
      Affiliate's participation
        in gain on forgiveness
        of debt                                         20,823        133,665
      Participation in debt
        extinguishment expense          193,532         58,521
      Affiliates' participation
        in income (loss) from 
        joint ventures                1,144,318        (69,819)       (16,160)
      Participation in (income)
        loss of joint 
        venture with an 
        affiliate                    (4,875,091)         2,596        104,619
      Depreciation of properties      1,373,849      1,747,385      1,747,384
      Amortization of deferred
        expenses                        131,305        141,321        210,353
      Net change in:
        Escrow deposits                  64,933        (29,146)      (266,569)
        Accounts and accrued
          interest receivable            (3,474)       (84,005)
        Prepaid expenses                301,752       (133,857)      (118,266)
        Accounts payable                (57,074)       (33,866)        74,025
        Due to affiliates                66,194        (44,815)         6,148
        Accrued liabilities                                           (11,687)
        Security deposits              (174,817)        38,519         (2,477)
                                  -------------- -------------- --------------
  Net cash provided by
    operating activities              1,626,239      1,516,837      1,790,896
                                  -------------- -------------- --------------
Investing activities:
  Proceeds from sales of 
    properties                       31,678,988
  Payment of selling costs             (700,889)
  Contributions to joint venture
    with an affiliate                                 (374,657)       (47,041)
  Distributions from joint 
    ventures with affiliates          2,495,139        328,378        131,556
                                  -------------- -------------- --------------
  Net cash provided by or (used 
    in) investing activities         33,473,238        (46,279)        84,515
                                  -------------- -------------- --------------

The accompanying notes are an integral part of the financial statements.
<PAGE>
                    BALCOR REALTY INVESTORS 85 - SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (AN ILLINOIS LIMITED PARTNERSHIP)

                           STATEMENTS OF CASH FLOWS
             for the years ended December 31, 1996, 1995 and 1994
                                  (Continued)

                                       1996           1995           1994
                                  -------------- -------------- --------------
Financing activities:

  Distributions to Limited 
    Partners                      $ (13,591,160) $    (443,190)
  Distributions to joint venture
    partners - affiliates            (1,399,775)      (192,659) $    (163,551)
  Contributions from joint 
    venture partners - affiliates        62,932                       252,311
  Repayment of mortgage notes
    payable                         (16,731,937)                  (18,700,000)
  Proceeds from issuance of 
    mortgage notes payable                                         16,795,600
  Proceeds from issuance of
    note payable                                                    1,350,000
  Release of capital improvement
    escrows                             639,000
  Funding of capital improvement 
    escrows                                                          (209,445)
  Payment of deferred expenses         (125,000)                     (842,617)
  Principal payments on mortgage     
    notes payable                      (376,093)      (489,850)      (308,772)
                                  -------------- -------------- --------------
  Net cash used in financing
    activities                      (31,522,033)    (1,125,699)    (1,826,474)
                                  -------------- -------------- --------------
Net change in cash and cash
  equivalents                         3,577,444        344,859         48,937
Cash and cash equivalents at
  beginning of year                   2,310,596      1,965,737      1,916,800
                                  -------------- -------------- --------------
Cash and cash equivalents at
  end of year                     $   5,888,040  $   2,310,596  $   1,965,737
                                  ============== ============== ==============

The accompanying notes are an integral part of the financial statements.
<PAGE>
                     BALCOR REALTY INVESTORS 85-SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (An Illinois Limited Partnership)

                         NOTES TO FINANCIAL STATEMENTS

1. Nature of the Partnership's Business:

Balcor Realty Investors 85-Series III A Real Estate Limited Partnership is
engaged principally in the operation of residential real estate located in
Duluth, Georgia and DeKalb County, Georgia.

2. Partnership Termination:

The Partnership Agreement provides for the dissolution of the Partnership upon
the occurrence of certain events, including the disposition of all interests in
real estate. During 1996, the Partnership sold the Country Ridge, Park Place -
Phase II and Shadowridge apartment complexes. The Lakeville Resort Apartments,
in which the Partnership owned a minority joint venture interest, was also sold
during 1996. In addition, the Partnership has entered into contracts to sell
its remaining two properties, North Hill Apartments and Howell Station
Apartments. The timing of the termination of the Partnership and final
distribution of cash will depend upon the nature and extent of liabilities and
contingencies which exist or may arise. Such contingencies may include legal
and other fees stemming from litigation involving the Partnership including,
but not limited to, the lawsuits discussed in Note 14 of Notes to the Financial
Statements. In the absence of any such contingency, the reserves will be paid
within twelve months of the last property being sold. In the event a
contingency arises, reserves may be held by the Partnership for a longer period
of time.

3. Accounting Policies:

(a) The preparation of the financial statements in conformity with generally
accepted accounting principles requires the General Partner to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could vary from those estimates.

(b) Depreciation expense is computed using the straight-line method. Rates used
in the determination of depreciation are based upon the following estimated
useful lives:

                                                    Years
                                                    -----
               Buildings and improvements             30
               Furniture and fixtures                  5

Maintenance and repairs are charged to expense when incurred. Expenditures for
improvements are charged to the related asset account.

Interest incurred while properties were under construction was capitalized.
<PAGE>
As properties are sold, the related costs and accumulated depreciation are
removed from the respective accounts. Any gain or loss on disposition is
recognized in accordance with generally accepted accounting principles.

(c) Effective January 1, 1995 the Partnership adopted Statement of Financial
Accounting Standards, No. 121 (SFAS 121), "Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of". Under SFAS 121, the
Partnership records its investments in real estate at the lower of cost or fair
value, and periodically assesses, but not less than on an annual basis,
possible impairment to the value of its properties. The General Partner
estimates the fair value of its properties based on the current sales price
less estimated closing costs. In the event the General Partner determines an
impairment in value has occurred, and the carrying amount of the real estate
asset will not be recovered, a provision is recorded to reduce the carrying
basis of the property to its estimated fair value. The General Partner
considers the method referred to above to result in a reasonable measurement of
a property's fair value, unless other factors affecting the property's value
indicate otherwise.

(d) Deferred expenses consist of loan financing and modification fees which are
amortized over the terms of the respective agreements. Upon sale, any remaining
balance is recognized as debt extinguishment expense and classified as an
extraordinary item.

(e) The Financial Accounting Standard Board's Statement No. 107, "Disclosures
About Fair Value of Financial Instruments", requires disclosure of fair value
information about financial instruments for which it is practicable to estimate
that value. Since quoted market prices are not available for the Partnership's
financial instruments, fair values have been based on estimates using present
value techniques. These techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, may not be realized in
immediate settlement of the instrument. Statement No. 107 does not apply to all
balance sheet items and excludes certain financial instruments and all
non-financial instruments such as real estate and investment in joint ventures
from its disclosure requirements.

(f) Revenue is recognized on an accrual basis in accordance with generally
accepted accounting principles.

(g) Investment in joint venture with an affiliate represents the Partnership's
40.25% interest, under the equity method of accounting, in a joint venture with
an affiliated partnership. Under the equity method of accounting, the
Partnership records its initial investment at cost and adjusts its investment
account for additional capital contributions, distributions and its share of
joint venture income or loss. 

(h) Cash and cash equivalents include all unrestricted, highly liquid
investments with an original maturity of three months or less. Cash is held or
invested in one financial institution.

(i) The Partnership is not liable for Federal income taxes and each partner
recognizes his proportionate share of the Partnership income or loss in his tax
return; therefore, no provision for income taxes is made in the financial
statements of the Partnership.
<PAGE>
(j) Several reclassifications have been made to the previously reported 1995
and 1994 statements to conform with the classifications used in 1996. These
reclassifications have not changed the 1995 and 1994 results.

4. Partnership Agreement:

The Partnership was organized on October 25, 1984. The Partnership Agreement
provides for Balcor Partners-XVIII to be the General Partner and for the
admission of Limited Partners through the sale of up to 70,000 Limited
Partnership Interests at $1,000 per Interest, 59,092 of which were sold on or
prior to December 31, 1985, the termination date of the offering.

Pursuant to the Partnership Agreement, Partnership losses will be allocated 99%
to the Limited Partners and 1% to the General Partner. One hundred percent of
Net Cash Receipts available for distribution shall be distributed to the
holders of Interests in proportion to their participating percentages as of the
record date for such distributions. In addition, there shall be accrued for the
General Partner as its distributive share from operations an amount equal to
approximately 1% of the total Net Cash Receipts being distributed which will be
paid only out of distributed Net Cash Proceeds. The accrued amount will be paid
as a part of the General Partner's share of distributed Net Cash Proceeds and
will be paid only out of distributed Net Cash Proceeds in excess of total
Original Capital plus a 6% Cumulative Distribution. Under certain
circumstances, the General Partner may participate in the Net Cash Proceeds of
the sale or refinancing of Partnership properties. The General Partner's
participation is limited to 15% of Net Cash Proceeds and is subordinated to the
return of Original Capital plus any deficiency in a Cumulative Distribution of
6% on Adjusted Original Capital to the holders of Interests.  The General
Partner has received no distributions pursuant to these provisions.

5. Mortgage Notes Payable:

Mortgage notes payable at December 31, 1996 and 1995 consisted of the
following:

                     Carrying    Carrying Current  Final
Property            Amount of   Amount of  Inter-  Matur- Current   Estimated
Pledged as           Notes at    Notes at   est     ity   Monthly    Balloon
Collateral           12/31/96    12/31/95   Rate    Date  Payment    Payment 
--------------     ----------   ---------- ------  ------ -------   ---------
Apartment Complexes:
  
Country Ridge            (A)  $8,798,060       (A)   (A)       (A)         (A)
                                                       
Howell Station   $ 6,467,081   6,532,938    7.940%  2001  $ 48,517 $ 6,153,000
                                                                               
                             
North Hill (B)    16,506,947  16,657,089    8.090%  2024   124,920  14,859,981
                   1,350,000   1,350,000       (B)   (B)        (B)       (B)
Park Place -
  Phase II               (C)   9,030,058       (C)   (C)        (C)       (C)
                                                                  
Shadowridge              (D)   8,059,925       (D)   (D)        (D)       (D)
                 ----------- -----------

    Total        $24,324,028 $50,428,070
                 =========== ===========
<PAGE>
(A) In June 1996, this property was sold. See Note 11 of Notes to Financial
Statements for additional information.  

(B) North Hill Apartments is owned by a joint venture ("Joint Venture")
consisting of the Partnership and an affiliate. In December 1994, the bonds
which funded the previous North Hill Apartments mortgage loan were repaid. The
Joint Venture repaid the existing mortgage loan of $18,700,000 with proceeds
from the new mortgage loan of $16,795,600, which was net of a discount of
$84,400, proceeds from a $1,350,000 note from an unaffiliated party, and Joint
Venture cash reserves. See Note 12 of Notes to Financial Statements for
additional information.

The $1,350,000 note to an unaffiliated party is non-interest bearing and is not
collateralized by the North Hill Apartments. It will be repaid only to the
extent North Hill Apartments' net sales proceeds exceed a certain predetermined
level. This property is currently under contract for sale. Based on the
projected sales price of the property, this note will not be repaid by the
Partnership. The note is included with Mortgage Notes Payable due to its
relationship to the North Hill Apartments.

(C) In September 1996, this property was sold. See Note 11 of Notes to
Financial Statements for additional information.

(D) In August 1996, this property was sold. See Note 11 of Notes to Financial
Statements for additional information.

The Partnership's loans described above require current monthly payments of
principal and interest.

Real estate with an aggregate carrying value of $19,189,921 at December 31,
1996 was pledged as collateral for repayment of mortgage loans.

Future annual maturities of the above mortgage notes payable during each of the
next five years are approximately as follows:

                     1997             $234,000
                     1998              254,000
                     1999              275,000
                     2000              298,000
                     2001              322,000

During 1996, 1995 and 1994, the Partnership incurred interest expense on
mortgage notes payable of $3,306,963, $4,259,221 and $3,564,778 and paid
interest expense of $3,306,963, $4,259,221 and $3,576,465, respectively.

6. Management Agreements:

As of December 31, 1996, the remaining properties owned by the Partnership are
under management agreements with a third-party management company. These
management agreements provide for annual fees of 5% of gross operating
receipts.
<PAGE>
7. Affiliates' Participation in Joint Ventures:

The North Hill Apartments is owned and Shadowridge Apartments was owned by
the Partnership and an affiliated partnership. The Shadowridge Apartments
was sold in August 1996. Profits and losses are allocated 75% to the
Partnership and 25% to the affiliate for North Hill Apartments, and 70% to
the Partnership and 30% to the affiliate for Shadowridge Apartments. All
assets, liabilities, income and expenses of the joint ventures are
included in the financial statements of the Partnership with the
appropriate adjustment to profit or loss for each affiliate's
participation. Net distributions of $1,336,843 and $192,659 were made to
joint venture partners during 1996 and 1995, respectively. A net
contribution of $88,760 was received in 1994. See Notes 11 and 12 for
additional information.

8. Investment in Joint Venture with an Affiliate:

The Lakeville Resort Apartments was owned by a joint venture consisting of the
Partnership and an affiliate. The Partnership and the affiliate hold
participating percentages in the joint venture of 40.25% and 59.75%,
respectively. In October 1996, the joint venture sold the property in an all
cash sale for $27,200,000, and the purchaser took title subject to the existing
first mortgage loan in the amount of $20,795,872. From the proceeds of the
sale, the joint venture paid $355,000 in selling costs. The joint venture
recognized a gain of $11,761,791 from the sale of this property, of which
$4,734,121 is the Partnership's share. For financial statement purposes, the
Partnership's share of the gain is included in participation in income of joint
venture with affiliate in 1996.

The Partnership received distributions from property operations of $261,615,
and a distribution of $2,233,524 representing the Partnership's share of net
proceeds from the sale of the property available for distribution. In
accordance with the sale agreement, the joint venture was required to withhold
$500,000 of the sale proceeds until February 1997, of which $201,250 is the
Partnership's share. The full amount of the holdback was released in February
1997.

The following information has been summarized from the December 31, 1996
financial statements of the above joint venture:

         Total liabilities                $   201,250
         Total income                       3,487,495
         Net loss before gain on sale 
           and extraordinary item          (4,688,425)
         Gain on sale                      11,761,791
         Extraordinary item:
           Debt extinguishment expense        480,825
         Net income                         6,592,542
<PAGE>
9. Tax Accounting:

The Partnership keeps its books in accordance with the Internal Revenue Code,
rules and regulations promulgated thereunder and existing interpretations
thereof. The accompanying financial statements, which are prepared in
accordance with generally accepted accounting principles, will differ from the
tax returns due to the different treatment of various items as specified in the
Internal Revenue Code. The net effect of these accounting differences is that
the net income for 1996 in the financial statements is $10,789,369 less than
the tax income of the Partnership for the same period.

10. Transactions with Affiliates:

Fees and expenses paid and payable by the Partnership to affiliates are:

                            Year Ended       Year Ended       Year Ended
                             12/31/96         12/31/95         12/31/94   
                          --------------   --------------   --------------
                           Paid  Payable    Paid  Payable    Paid  Payable
                          ------ -------   ------ -------   ------ -------

Property management fees     None    None     None    None $500,733    None
Reimbursement of expenses
  to the General Partner,
  at cost:
    Accounting            $14,290 $14,417  $40,855  $2,792   64,274 $23,131
    Data processing         5,166   2,397   26,055   2,074   36,034   9,534
    Investor communica-
      tions                                  4,926    None   12,306   4,134
    Legal                  11,001  11,098   19,064   2,828    8,561   3,118
    Portfolio management   38,243  38,580   81,974  11,039   45,636  20,651
    Property sales
      administration       18,846  19,012    3,006     577     None    None
    Other                    None    None    5,665    None   13,887   3,557

Allegiance Realty Group, Inc., an affiliate of the General Partner, managed all
of the Partnership's properties until the affiliate was sold to a third party
in November 1994.

The Partnership participates in an insurance deductible program with other
affiliated partnerships in which the program pays claims up to the amount of
the deductible under the master insurance policies for its properties. The
program is administered by an affiliate of the General Partner who receives no
fee for administering the program; however, the General Partner is reimbursed
for program expenses. The Partnership paid premiums to the deductible insurance
program of $16,999, $82,931 and $104,139 for 1996, 1995 and 1994, respectively.

11. Property Sales:

(a) In June 1996, the Partnership sold the Country Ridge Apartments in an all
cash sale for $15,950,000. From the proceeds of the sale, the Partnership paid
$8,770,310 to the third party mortgage holder in full satisfaction of the first
mortgage loan, and paid $134,625 in selling costs. The basis of the property
was $6,741,814, which is net of accumulated depreciation of $3,705,963. For
financial statement purposes, the Partnership recognized a gain of $9,073,561
from the sale of this property.
<PAGE>
(b) The Shadowridge Apartments was owned by a joint venture consisting of the
Partnership and an affiliate. The Partnership and the affiliate held
participating percentages in the joint venture of 70% and 30%, respectively. In
August 1996, the joint venture sold the property in an all cash sale for
$12,600,000. From the proceeds of the sale, the joint venture paid $7,961,627
to the third party mortgage holder in full satisfaction of the first mortgage
loan, and paid $384,545 in selling costs. The basis of the property was
$8,151,131, which is net of accumulated depreciation of $4,406,663. For
financial statement purposes, the Partnership recognized a gain of $4,064,324
from the sale of this property, of which $1,219,297 is the minority joint
venture partner's share.

(c) In September 1996, the Partnership sold the Park Place Apartments - Phase
II in an all cash sale for $12,125,000. The purchaser of the property took
title subject to the existing first mortgage loan in the amount of $8,996,012.
From the proceeds of the sale, the Partnership paid $181,719 in selling costs.
The basis of the property was $5,552,752, which is net of accumulated
depreciation of $3,932,895. For financial statement purposes, the Partnership
recognized a gain of $6,390,529 from the sale of this property.

12. Extraordinary Items:

(a) In connection with the sales of the Country Ridge, Shadowridge and Park
Place - Phase II apartment complexes during 1996, the Partnership wrote off the
remaining unamortized deferred expenses in the amount of $440,081. This amount
was recognized as an extraordinary item and classified as debt extinguishment
expense, of which $7,165 represents the Shadowridge Apartments minority joint
venture partner's share.

(b) The Partnership owned a minority joint venture interest in Lakeville Resort
Apartments. In connection with the sale during October 1996, the joint venture
wrote off the remaining unamortized deferred expenses. These amounts were
recognized as an extraordinary item and classified as debt extinguishment
expense. The Partnership's share of the extraordinary item was $193,532.

(c) Shadowridge Apartments was owned by a joint venture consisting of the
Partnership and an affiliate. During 1995, the joint venture recognized an
extraordinary gain on forgiveness of debt of $69,409 in connection with a
settlement reached with the seller, of which $20,823 represents the affiliate's
share.

(d) The Partnership owned a minority joint venture interest in Lakeville Resort
Apartments. In June 1995, the mortgage note was refinanced with a new lender.
In connection with this transaction, the Partnership recognized extraordinary
debt extinguishment expense of $58,521.

(e) North Hill Apartments is owned by a joint venture consisting of the
Partnership and an affiliate. In connection with the December 1994 mortgage
loan refinancing, the joint venture received a refund of the escrow account
held by the trustee representing the amount which would have been paid to
Mutual Benefit Life Insurance Company as its 1% guaranty fee on the original
North Hill Apartments' mortgage loan. As a result, the Partnership recognized a
$534,659 extraordinary gain on forgiveness of debt in 1994, of which $133,665
represents the affiliate's share.
<PAGE>
13. Fair Value of Financial Instruments:

The carrying amounts and fair values of the Partnership's financial instruments
at December 31, 1996 and 1995 are as follows:

The carrying value of cash and cash equivalents, accounts and accrued interest
receivable and accounts payable approximates fair value.

Mortgage Notes Payable: Based on borrowing rates available to the Partnership
at the end of 1996 and 1995 for mortgage loans with similar terms and
maturities, the fair value of the mortgage notes payable approximates the
carrying value.

14. Contingencies:

The Partnership is currently involved in two lawsuits whereby the Partnership
and certain affiliates have been named as defendants alleging substantially
similar claims involving certain federal securities law violations with regard
to the adequacy and accuracy of disclosures of information concerning, as well
as marketing efforts related to, the offering of the Limited Partnership
Interests of the Partnership. The defendants continue to vigorously contest
these actions. A plaintiff class has not been certified in either action and,
no determinations of the merits have been made. It is not determinable at this
time whether or not an unfavorable decision in either action would have a
material adverse impact on the financial position, operations and liquidity of
the Partnership. The Partnership believes it has meritorious defenses to
contest the claims.

15. Subsequent Event:

In January 1997, the Partnership made a distribution of $4,402,354 ($74.50 per
Interest) to the holders of Limited Partnership Interests. This amount includes
the regular quarterly distribution of available Net Cash Receipts of $7.50 per
Interest and a special distribution of Net Cash Proceeds of $67.00 per Interest
from proceeds received in connection with the sale of Lakeville Resort
Apartments and the release of the Country Ridge and Park Place - Phase II
apartment complexes holdbacks.
<PAGE>
                                 BALCOR REALTY INVESTORS 85-SERIES III
                                   A REAL ESTATE LIMITED PARTNERSHIP
                                   (An Illinois Limited Partnership)
<TABLE>
                        SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                                        as of December 31, 1996
<CAPTION>
        Col. A                 Col. B          Col. C                        Col. D 
---------------------         --------  --------------------   ---------------------------------
                                            Initial Cost                Cost Adjustments
                                           to Partnership          Subsequent to Acquisition
                                        --------------------   ---------------------------------
                                                  Buildings               Carrying     Reduction
                               Encum-              and Im-                 Costs       of Basis
     Description              brances     Land    provements                (a)           (f)
---------------------         -------   -------- ------------            ---------     ---------
<S>                             <C>  <C>          <C>                   <C>           <C>
Howell Station Apts.,
  a 228 unit complex in
  Duluth, GA                    (d)      765,000    7,314,000                93,803   $ (82,212)
North Hill Apts.,
  a 420 unit complex in
  DeKalb County, GA             (d)    2,460,000   20,903,000                20,235    (544,251)
                                     -----------  -----------            ----------   ---------
    Total                            $ 3,225,000  $28,217,000              $114,038   $(626,463)
                                     ===========  ===========            ==========   =========
</TABLE>
<PAGE>
                                 BALCOR REALTY INVESTORS 85-SERIES III
                                   A REAL ESTATE LIMITED PARTNERSHIP
                                   (An Illinois Limited Partnership)
<TABLE>
                        SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                                        as of December 31, 1996
                                              (Continued)
<CAPTION>
       Col. A                          Col. E                 Col. F      Col. G   Col. H     Col. I
-------------------       --------------------------------   --------    --------  ------ --------------
                               Gross Amounts at Which                                        Life Upon
                             Carried at Close of Period                                    Which Depre-
                          -------------------------------                                   ciation in
                                    Buildings               Accumulated    Date     Date   Latest Income
                                     and Im-       Total     Deprecia-   of Con-    Acq-     Statement
    Description             Land    provements     (b)(c)      tion(c)   struction uired    is Computed
-------------------       --------  ----------   ----------   ---------  --------- -----  --------------
<S>                    <C>         <C>         <C>          <C>             <C>    <C>          <C>
Howell Station Apts.,
  a 228 unit complex in
  Duluth, GA               757,168   7,333,423    8,090,591   3,129,909     1985    8/85        (e)
North Hill Apts.,
  a 420 unit complex in
  DeKalb County, GA      2,404,824  20,434,160   22,838,984   8,609,745     1985    7/85        (e)
                       ----------- -----------  ----------- -----------
    Total              $ 3,161,992 $27,767,583  $30,929,575 $11,739,654
                       =========== ===========  =========== ===========
</TABLE>
<PAGE>
                     BALCOR REALTY INVESTORS 85-SERIES III
                       A REAL ESTATE LIMITED PARTNERSHIP
                       (An Illinois Limited Partnership)

                             NOTES TO SCHEDULE III

(a) Consists of legal fees, appraisal fees, title costs, other related
professional fees and capitalized construction-period interest.

(b) The aggregate cost of land for Federal income tax purposes is $3,227,812
and the aggregate cost of buildings and improvements for Federal income tax
purposes is $28,241,613. The total of these is $31,469,425.

(c)                        Reconciliation of Real Estate
                           -----------------------------

                                       1996         1995         1994   
                                    ----------   ----------   ----------

    Balance at beginning of year   $63,420,793  $63,420,793  $63,420,793

    Reductions during year:
      Sales of properties          (32,491,218)
                                   -----------  -----------  -----------

    Balance at close of year        30,929,575  $63,420,793  $63,420,793
                                   ===========  ===========  ===========

                  Reconciliation of Accumulated Depreciation
                  ------------------------------------------

                                       1996         1995         1994   
                                    ----------   ----------   ----------

    Balance at beginning of year   $22,411,326  $20,663,941  $18,916,557

    Depreciation expense for
      the year                       1,373,849    1,747,385    1,747,384

    Accumulated depreciation of
      properties sold              (12,045,521)                         
                                   -----------  -----------  -----------

    Balance at close of year        11,739,654  $22,411,326  $20,663,941
                                   ===========  ===========  ===========

(d) See description of Mortgage Notes Payable in Note 5 of Notes to Financial
Statements.

(e) Depreciation expense is computed based upon the following estimated useful
lives:

                                                    Years
                                                    -----
               Buildings and improvements             30
               Furniture and fixtures                  5
<PAGE>
(f) Guaranteed income earned on properties under the terms of certain
management and guarantee agreements was recorded by the Partnership as a
reduction of the basis of the property to which the guaranteed income related.
<PAGE>