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

                                      FORM 10-K

               |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                           SECURITIES EXCHANGE ACT OF 1934

                      FOR FISCAL YEAR ENDED: SEPTEMBER 30, 1997

                                          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:  0-10979

            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
            --------------------------------------------------------
             (Exact name of registrant as specified in its charter)

        Delaware                                                 13-3038189
-----------------------                                     -------------------
(State of organization)                                        (I.R.S. Employer
                                                            Identification No.)

265 Franklin Street, Boston, Massachusetts                            02110
-------------------------------------------------------------------------------
(Address of principal executive office)                              (Zip Code)

Registrant's telephone number, including area code:  (617) 439-8118
                                                     --------------

Securities registered pursuant to Section 12(b) of the Act:
                                                         Name of each exchange
Title of each class                                        on which registered
-------------------                                        -------------------
     None                                                        None 

Securities registered pursuant to Section 12(g) of the Act:
                        UNITS OF LIMITED PARTNERSHIP INTEREST
                        -------------------------------------
                                   (Title of class)

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|

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 |_|.

State the aggregate market value of the voting stock held by  non-affiliates  of
the registrant. Not applicable.
                         DOCUMENTS INCORPORATED BY REFERENCE
Documents                                                  Form 10-K Reference
---------                                                  -------------------
Prospectus of registrant dated                                 Part IV
December 3, 1980, as supplemented

Current Report on Form 8-K                                     Page IV
of registrant dated August 1, 1997

<PAGE>


             PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
                                    1997 FORM 10-K

                                  TABLE OF CONTENTS

Part I                                                                  Page
------                                                                  ----

Item  1           Business                                               I-1

Item  2           Properties                                             I-3

Item  3           Legal Proceedings                                      I-3

Item  4           Submission of Matters to a Vote of Security Holders    I-5

Part  II
--------   

Item  5           Market for the Partnership's Limited Partnership
                  Interests and Related Security Holder Matters          II-1

Item  6           Selected Financial Data                                II-1

Item  7           Management's Discussion and Analysis of Financial 
                  Condition and Results of Operations                    II-2

Item  8           Financial Statements and Supplementary Data            II-7

Item  9           Changes in and Disagreements with Accountants on
                  Accounting and Financial Disclosure                    II-7

Part III
--------

Item 10           Directors and Principal Executive Officers of the 
                  Partnership                                            III-1

Item 11           Executive Compensation                                 III-2

Item 12           Security Ownership of Certain Beneficial Owners 
                  and Management                                         III-3

Item 13           Certain Relationships and Related Transactions         III-3

Part  IV
--------

Item 14           Exhibits, Financial Statement Schedules and Reports 
                  on Form 8-K                                            IV-1

Signatures                                                               IV-2

Index to Exhibits                                                        IV-3

Financial Statements and Supplementary Data                       F-1 to F-29


<PAGE>
 
      This Form 10-K contains  forward-looking  statements within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934. The  Partnership's  actual results could differ materially
from those set forth in the  forward-looking  statements.  Certain  factors that
might cause such a difference  are  discussed in Item 7 in the section  entitled
"Certain Factors Affecting Future Operating  Results"  beginning on page II-5 of
this Form 10-K.

                                    PART I

Item 1.  Business

      Paine  Webber   Income   Properties   Three   Limited   Partnership   (the
"Partnership")  is a limited  partnership  formed in June 1980 under the Uniform
Limited Partnership Act of the State of Delaware for the purpose of investing in
a  diversified  portfolio  of  existing  income-producing  properties  including
shopping  centers and apartment  complexes.  The Partnership sold $21,550,000 in
Limited Partnership units (the "Units"), representing 21,550 Units at $1,000 per
unit,  during the offering period  pursuant to a Registration  Statement on Form
S-11 filed under the Securities Act of 1933 (Registration No. 2-68360).  Limited
Partners will not be required to make any additional contributions.

      The  Partnership  originally  invested  the  net  proceeds  of the  public
offering,  either  directly  or  through  joint  venture  partnerships,  in  six
operating  properties.  As discussed below,  through September 30, 1997 three of
the operating properties had been sold, and the Partnership sold its interest in
another  joint  venture to its  co-venture  partner  during  fiscal 1997.  As of
September 30, 1997,  the  Partnership  owned,  directly or through joint venture
partnerships,  the  properties or interests in the  properties  set forth in the
following table:

Name of Joint Venture                        Date of
Name and Type of Property                    Acquisition   Type of
Location                          Size       of Interest   Ownership (1)
------------------------------    ------     -----------   -------------------

Boyer Lubbock Associates          151,857     6/30/81      Fee ownership of land
Central Plaza Shopping Center     gross                    and improvements
Lubbock, Texas                    leasable                 (through joint
                                  sq. ft.                  venture).

Northeast Plaza Shopping Center   121,005     9/25/81      Fee ownership of land
Sarasota, Florida                 gross                    and improvements
                                  leasable                 subject to a master 
                                  sq. ft.                  lease.

(1) See Notes to the  Financial  Statements  filed with this Annual Report for a
    description  of  the  long-term   mortgage   indebtedness   secured  by  the
    Partnership's  operating  property  investments and for a description of the
    agreements  through  which the  Partnership  has acquired  these real estate
    investments.

      The Partnership previously had investment interests in the Briarwood Joint
Venture,  which owned the Briarwood  Apartments and Gatewood Apartments in Bucks
County, Pennsylvania;  Camelot Associates, which owned the Camelot Apartments in
Fairfield, Ohio; and Pine Trail Partnership, which owned the Pine Trail Shopping
Center in West Palm Beach,  Florida.  On December 20, 1984, the Partnership sold
its investment in the Briarwood  Joint Venture for cash of $7,490,000 and a note
receivable.   See  Note  6  to  the  financial  statements  of  the  Partnership
accompanying this Annual Report for a further discussion of this transaction and
the outstanding note receivable.  On June 19, 1996,  Camelot Associates sold the
Camelot Apartments to an unrelated third party for $15,150,000.  The Partnership
received  net sales  proceeds of  approximately  $5.9  million  after  deducting
closing costs, the repayment of two outstanding first mortgage loans, the buyout
of an underlying ground lease and the  co-venturers'  share of the net proceeds.
See Note 5 to the financial  statements  of the  Partnership  accompanying  this
Annual Report for a further  discussion of this transaction.  On August 1, 1997,
the  Partnership  sold its interest in the Pine Trail  Partnership  to its joint
venture  partner  for a net  price of  $6,150,000.  See Note 5 to the  financial
statements  of the  Partnership  accompanying  this Annual  Report for a further
discussion of this transaction.


<PAGE>


      The Partnership's investment objectives are to:

(1) provide the Limited Partners with cash distributions  which, to some extent,
    will not constitute taxable income;
(2) preserve and protect Limited Partners'capital; 
(3) achieve long-term appreciation in the value of its properties;  and 
(4) provide a build up of equity through the reduction of mortgage loans on its
    properties.

      Through  September 30, 1997, the Limited Partners had received  cumulative
cash distributions totalling approximately $34,311,000,  or approximately $1,619
per original $1,000 investment for the Partnership's earliest investors.  Of the
total distributions,  approximately  $7,516,000,  or $348.75 per original $1,000
investment,  represents  proceeds  from the sale of the  Briarwood  and Gatewood
Apartments in fiscal 1985;  approximately  $108,000,  or $5 per original  $1,000
investment,  represents proceeds from the fiscal 1986 repayment of an additional
investment that was made in Northeast Plaza;  approximately  $5,517,000, or $256
per original $1,000 investment, represents proceeds from the sale of the Camelot
Apartments in fiscal 1996; and approximately $6,147,000, or $285.25 per original
$1,000  investment,  represents  proceeds  from  the  sale of the  Partnership's
interest in the Pine Trail  Shopping  Center during  fiscal 1997.  The remaining
distributions   have  been  made  from  the  net  operating  cash  flow  of  the
Partnership. A substantial portion of such distributions has been sheltered from
current  taxable  income.  Beginning  with the first quarter of fiscal 1998, the
Partnership  will be paying  quarterly  distributions of excess cash flow at the
rate of 5% per annum on a remaining capital account balance of $105 per original
$1,000 investment.  In addition,  the Partnership retains its ownership interest
in two of its six original investment  properties.  The Partnership's success in
meeting  its  capital  appreciation  objective  will  depend  upon the  proceeds
received from the final liquidation of its remaining investments.  The amount of
such proceeds will ultimately depend upon the value of the underlying investment
properties  at the time of their final  disposition,  which cannot  presently be
determined.  At the present time, real estate values for retail shopping centers
in certain markets are being  adversely  impacted by the effects of overbuilding
and  consolidations  among  retailers  which have  resulted in an  oversupply of
space.  Currently,  occupancy  at both  of the  Partnership's  remaining  retail
shopping  centers  remain high and operations to date do not appear to have been
affected by this general trend.

      As discussed further in the notes to the financial statements,  management
believes that the Partnership's efforts to sell or refinance the Northeast Plaza
property  have been impeded by  potential  lender  concerns of an  environmental
nature with respect to the property. During 1990, it was discovered that certain
underground  storage tanks of a Mobil service  station  located  adjacent to the
shopping center had leaked and  contaminated the ground water in the vicinity of
the station.  Since the time that the  contamination  was discovered,  Mobil has
investigated  the problem and is progressing with efforts to remedy the soil and
ground water  contamination  under the supervision of the Florida  Department of
Environmental  Regulation,  which has  approved  Mobil's  remedial  action plan.
During  fiscal  1990,  the  Partnership  had  obtained a formal  indemnification
agreement  from Mobil Oil  Corporation in which Mobil agreed to bear the cost of
all damages and required clean-up expenses.  Furthermore,  Mobil indemnified the
Partnership  against its inability to sell,  transfer or obtain financing on the
property because of the  contamination.  As a result of the contamination of the
ground water at Northeast  Plaza,  the Partnership has incurred certain damages,
primarily  related to the  inability  to sell the  property and to delays in the
process of refinancing the property's mortgage indebtedness. The Partnership has
incurred  significant  out-of-pocket  and legal expenses in connection with such
sale and refinancing  efforts.  Despite repeated requests by the Partnership for
compensation under the terms of the indemnification agreement, to date Mobil has
refused to  compensate  the  Partnership  for any of its  damages.  As discussed
further in Item 3, the Partnership initiated legal proceedings against Mobil for
breach of indemnity and property damage in fiscal 1993.  Such legal  proceedings
continue to be ongoing at the present  time.  The  Partnership  continues  to be
concerned about the impact of this contamination on the Partnership's ability to
sell this  investment  on  favorable  terms in the future.  The outcome of these
legal proceedings cannot presently be determined.

      The  Partnership's  two  remaining  operating  properties  are both retail
shopping  centers  which are located in real  estate  markets in which they face
significant  competition  for the revenues they generate.  The shopping  centers
compete for  long-term  retail  tenants with  numerous  projects of similar type
generally  on the  basis  on  location,  rental  rates,  tenant  mix and  tenant
improvement allowances.

      The Partnership has no real estate investments  located outside the United
States.  The  Partnership  is  engaged  solely in the  business  of real  estate
investment,  therefore,  presentation of information  about industry segments is
not applicable.

      The  Partnership  has no  employees;  it  has,  however,  entered  into an
Advisory  Contract with  PaineWebber  Properties  Incorporated  (the "Adviser"),
which is  responsible  for the  day-to-day  operations of the  Partnership.  The
Adviser is a wholly-owned  subsidiary of  PaineWebber  Incorporated  ("PWI"),  a
wholly-owned subsidiary of PaineWebber Group, Inc. ("PaineWebber").

      The General  Partner of the Partnership is Third Income  Properties,  Inc.
(the "General Partner"),  a wholly-owned  subsidiary of PaineWebber.  Subject to
the General  Partner's  overall  authority,  the business of the  Partnership is
managed by the Adviser.

      The terms of  transactions  between the  Partnership and affiliates of the
General  Partner  of the  Partnership  are set forth in Items 11 and 13 below to
which reference is hereby made for a description of such terms and transactions.

Item 2.  Properties

      As of September 30, 1997, the Partnership  owned one property directly and
owned an interest in one operating property through a joint venture partnership.
Such  properties  are referred to under Item 1 above to which  reference is made
for the name, location and description of each property.

      Occupancy  figures  for each fiscal  quarter  during  1997,  along with an
average for the year, are presented below for each property:

                                           Percent Leased At
                              -------------------------------------------------
                                                                        Fiscal
                                                                        1997
                              12/31/96   3/31/97    6/30/97   9/30/97   Average
                              --------   -------    -------   -------   -------

Central Plaza                   92%       92%       92%        92%       92%

Northeast Plaza Shopping 
 Center                        100%      100%      100%       100%      100%

Pine Trail Shopping Center (1)  97%       97%       96%        N/A       N/A

(1) The Partnership's  interest in the Pine Trail property was sold on August 1,
    1997.

Item 3.  Legal Proceedings

Mobil Oil Corporation Litigation
--------------------------------

      As discussed  further in Item 7, during fiscal 1993 the Partnership  filed
suit against Mobil Oil Corporation  because of Mobil's failure to compensate the
Partnership under the terms of an indemnification  agreement between the parties
related to the soil and ground water  contamination  affecting the Partnership's
Northeast  Plaza  Shopping  Center  investment.  Management  believes  that  the
Partnership's  efforts to sell or refinance  the Northeast  Plaza  property have
been impeded by potential buyer and lender concerns of an  environmental  nature
with  respect to the  property.  During  1990,  it was  discovered  that certain
underground  storage tanks of a Mobil service  station  located  adjacent to the
shopping center had leaked and  contaminated the ground water in the vicinity of
the station.  Since the time that the  contamination  was discovered,  Mobil has
investigated  the problem and is progressing  with efforts to remediate the soil
and ground water  contamination  under the supervision of the Florida Department
of  Environmental  Protection,  which has approved Mobil's remedial action plan.
During  fiscal  1990,  the  Partnership  had  obtained a formal  indemnification
agreement  from Mobil Oil  Corporation in which Mobil agreed to bear the cost of
all damages and required clean-up expenses.  Furthermore,  Mobil indemnified the
Partnership  against its inability to sell,  transfer or obtain financing on the
property  because  of the  contamination.  Subsequent  to the  discovery  of the
contamination,   the  Partnership  experienced  difficulty  in  refinancing  the
mortgages on the property that matured in 1991.  The existence of  contamination
on the property  impacted the  Partnership's  ability to obtain  standard market
financing.  Ultimately, the Partnership was able to refinance its first mortgage
at a substantially reduced loan-to-value ratio. In addition, the Partnership was
unable to sell the property at an  uncontaminated  market price. The Partnership
also retained  outside counsel and  environmental  consultants to review Mobil's
remediation  efforts  and has  incurred  significant  out-of-pocket  expenses in
connection with this situation. Despite repeated requests by the Partnership for
compensation under the terms of the indemnification agreement, to date Mobil has
refused to compensate the Partnership  for any of its damages.  During the first
quarter of fiscal 1993, the  Partnership  filed suit against Mobil for breach of
indemnity  and property  damage.  On April 28,  1995,  Mobil was  successful  in
obtaining a Partial  Summary  Judgment  which  removed the case from the Federal
Court system.  Subsequently,  the Partnership has filed an action in the Florida
State Court system.  This action is for substantially all of the same claims and
utilizes the substantial  discovery and trial preparation work already completed
for the Federal case. The  Partnership is seeking  judgment  against Mobil which
would award the Partnership  compensatory  damages,  costs,  attorneys' fees and
such other relief as the Court may deem proper.

      On November 14, 1996, the state court granted the Partnership's Motion for
Partial Summary Judgment as to liability with regard to the Partnership's claims
for damages due to Mobil's trespass and Mobil's creation of a private  nuisance.
Having established  liability,  the Partnership is entitled to any diminution in
market value of the property caused by the  contamination.  This Partial Summary
Judgment was upheld on appeal. The Partnership's  expert appraiser has estimated
that, upon completion of the remediation,  the diminution in value caused by the
stigma of previous  contamination  will be approximately  $1.5 million.  Mobil's
expert  appraiser  has  testified  that the  contamination  has not  caused  any
diminution in the market value of the property.

      A change  in  Florida  state  law  occurred  in 1996  which  may cause the
completion of the remediation to be extended beyond the currently  projected one
to three years. This possible extension could have a negative impact upon a sale
of the property,  should such a sale occur prior to the actual completion of the
remediation.  In  response  to this  change in the law and to the  discovery  of
certain  grossly  negligent,  wanton  or  intentional  conduct  by  Mobil in the
creation of the contamination,  evidence was presented to the Court in an effort
to allow for the amendment of the Complaint. The Court allowed the amendment. In
addition  to the  causes of  action  set forth in the  original  Complaint,  the
Amended  Complaint  seeks  injunctive  relief  to force  Mobil to  complete  the
remediation on an expedited basis and also seeks punitive damages.

      During  November 1996, the  Partnership  and Mobil attempted to settle the
action through  mediation.  A settlement was not achieved.  Mobil's  proposal to
settle the case, which included a proposed purchase of the contaminated  portion
of the  Northeast  Plaza  property from the  Partnership,  failed due to Mobil's
inability  to  obtain a zoning  variance  which  was  necessary  to make  such a
transaction  possible.  The matter is set for a jury trial  during the  two-week
period  commencing  April 6, 1998. The completion of discovery will occur during
the second quarter of fiscal 1998. The  Partnership is seeking damages in excess
of $2,000,000.  Subject to the foregoing,  it is impossible to determine at this
time, with reasonable certainty, the likely range of potential recovery, if any,
by the Partnership.

Unitholder Litigation
---------------------

      In November  1994,  a series of  purported  class  actions  (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York concerning PaineWebber Incorporated's sale and
sponsorship of various limited partnership investments,  including those offered
by the Partnership.  The lawsuits were brought against PaineWebber  Incorporated
and  Paine  Webber  Group,  Inc.  (together  "PaineWebber"),  among  others,  by
allegedly dissatisfied  partnership investors.  In March 1995, after the actions
were  consolidated  under  the  title  In  re  PaineWebber  Limited  Partnership
Litigation,  the plaintiffs  amended their  complaint to assert claims against a
variety of other defendants, including Third Income Properties, Inc., which is a
General Partner of the  Partnership and an affiliate of PaineWebber.  On May 30,
1995, the court certified  class action  treatment of the claims asserted in the
litigation.

      The amended complaint in the New York Limited  Partnership Actions alleged
that, in connection with the sale of interests in Paine Webber Income Properties
Three Limited Partnership,  PaineWebber, Third Income Properties, Inc. failed to
provide adequate disclosure of the risks involved; (2) made false and misleading
representations  about  the  safety  of the  investments  and the  Partnership's
anticipated performance;  and (3) marketed the Partnership to investors for whom
such investments were not suitable. The plaintiffs, who purported to be suing on
behalf of all  persons who  invested in Paine  Webber  Income  Properties  Three
Limited  Partnership,  also alleged that  following the sale of the  partnership
interests,   PaineWebber  and  Third  Income  Properties,   Inc.  misrepresented
financial information about the Partnership's value and performance. The amended
complaint  alleged that PaineWebber and Third Income  Properties,  Inc. violated
the Racketeer Influenced and Corrupt  Organizations Act ("RICO") and the federal
securities  laws.  The  plaintiffs   sought   unspecified   damages,   including
reimbursement  for all sums  invested  by them in the  partnerships,  as well as
disgorgement  of all fees and  other  income  derived  by  PaineWebber  from the
limited  partnerships.  In addition,  the plaintiffs  also sought treble damages
under RICO.

      In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the New York Limited Partnership Actions outlining the terms under
which the  parties  agreed to settle the case.  Pursuant to that  memorandum  of
understanding,  PaineWebber  irrevocably  deposited  $125 million into an escrow
fund under the  supervision of the United States District Court for the Southern
District of New York to be used to resolve the  litigation in accordance  with a
definitive  settlement  agreement  and plan of  allocation.  On July  17,  1996,
PaineWebber  and the class  plaintiffs  submitted a definitive  settlement  that
provides for the complete  resolution of the class action litigation,  including
releases in favor of the  Partnership  and PWPI,  and the allocation of the $125
million settlement fund among investors in the various partnerships and REITs at
issue in the case. As part of the settlement, PaineWebber also agreed to provide
class  members  with  certain  financial  guarantees  relating  to  some  of the
partnerships  and REITs. The details of the settlement are described in a notice
mailed  directly to class members at the direction of the court. A final hearing
on the fairness of the proposed  settlement  was held in December  1996,  and in
March 1997 the court announced its final approval of the settlement. The release
of the $125  million  of  settlement  proceeds  had  been  delayed  pending  the
resolution  of an appeal of the  settlement  agreement  by two of the  plaintiff
class  members.  In July 1997, the United States Court of Appeals for the Second
Circuit upheld the settlement  over the objections of the two class members.  As
part of the settlement agreement, PaineWebber agreed not to seek indemnification
from the related  partnerships and real estate investment trusts at issue in the
litigation  (including the  Partnership)  for any amounts that it is required to
pay under the settlement.

      In June  1996,  approximately  50  plaintiffs  filed  an  action  entitled
Bandrowski v. PaineWebber Inc. in Sacramento,  California Superior Court against
PaineWebber   Incorporated  and  various  affiliated   entities  concerning  the
plaintiff's purchases of various limited partnership interests,  including those
offered by the  Partnership.  The complaint  alleged,  among other things,  that
PaineWebber and its related entities committed fraud and  misrepresentation  and
breached  fiduciary  duties  allegedly  owed to the  plaintiffs  by  selling  or
promoting  limited   partnership   investments  that  were  unsuitable  for  the
plaintiffs and by overstating the benefits,  understating  the risks and failing
to state  material  facts  concerning  the  investments.  The  complaint  sought
compensatory  damages of $3.4 million plus punitive damages against PaineWebber.
In September  1996, the court  dismissed many of the  plaintiffs'  claims in the
Bandrowski action as barred by applicable  securities  arbitration  regulations.
Mediation with respect to the Bandrowski  action was held in December 1996. As a
result of such mediation,  a settlement  between  PaineWebber and the plaintiffs
was reached which  provided for the complete  resolution  of this matter.  Final
releases and dismissals  with regard to this action were received  during fiscal
1997.

      Based on the  settlement  agreements  discussed  above covering all of the
outstanding  unitholder  litigation,  management believes that the resolution of
these  matters will not have a material  impact on the  Partnership's  financial
statements, taken as a whole.

      The  Partnership  is not  subject  to any  other  material  pending  legal
proceedings.

Item 4.  Submission of Matters to a Vote of Security Holders

      None.

<PAGE>

                                   PART II

Item 5.  Market  for the  Partnership's  Limited  Partnership  Interests  and
Related Security Holder Matters

      At  September  30, 1997,  there were 1,547 record  holders of Units in the
Partnership.  There is no public market for the Units, and it is not anticipated
that a public market for Units will develop.  Upon request,  the General Partner
will  endeavor to assist a  Unitholder  desiring  to transfer  his Units and may
utilize the services of PWI in this  regard.  The price to be paid for the Units
will be subject to negotiation by the  Unitholder.  The General Partner will not
redeem or repurchase Units.

      Reference is made to Item 6 below for a discussion  of cash  distributions
made to the Limited Partners during fiscal 1997.

Item 6.  Selected Financial Data

           Paine Webber Income Properties Three Limited Partnership
                     (In thousands, except per Unit data)

                                     Years Ended September 30,
                         ----------------------------------------------------
                           1997       1996         1995      1994       1993
                           ----       ----         ----      ----       ----

Revenues                $  579       $   562     $   492   $   483    $   483

Operating loss          $ (130)      $   (80)    $  (246)  $  (197)   $  (154)

Partnership's share
of ventures' income     $  403       $   696     $   510   $   442    $   332

Partnership's share 
  of gain on sale of 
  operating investment 
  property                   -       $  5,926          -         -          -

Gain on sale of joint
  venture interest      $3,565             -           -         -          -

Net income              $3,838       $ 6,542     $   264   $   245    $   178

Per Limited Partnership Unit:
 
  Net income           $176.32       $300.56     $ 12.14   $ 11.26    $  8.16

   Cash distributions
     from operations   $ 19.52       $ 19.40     $ 19.40   $ 19.40    $ 19.40

   Cash distributions
     from sale 
      transactions     $285.25       $256.00          -         -           -

Total assets           $ 4,767       $ 7,645     $ 7,151   $ 7,429    $ 8,271

Mortgage note payable  $ 1,278       $ 1,420     $ 1,549   $ 1,667    $ 2,245

      The above selected  financial data should be read in conjunction  with the
financial  statements  and  related  notes  appearing  elsewhere  in this Annual
Report.

      The above per  Limited  Partnership  Unit  information  is based  upon the
21,550 Limited Partnership Units outstanding during each year.



<PAGE>


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

Information Relating to Forward-Looking Statements
--------------------------------------------------

      The following  discussion of financial condition includes  forward-looking
statements  which  reflect  management's  current  views with  respect to future
events and  financial  performance  of the  Partnership.  These  forward-looking
statements  are  subject to certain  risks and  uncertainties,  including  those
identified below under the heading  "Certain Factors  Affecting Future Operating
Results",  which could cause actual results to differ materially from historical
results or those anticipated. The words "believe,"  "expect,"  "anticipate," and
similar expressions identify forward-looking  statements.  Readers are cautioned
not to place undue reliance on these forward-looking statements, which were made
based on facts and conditions as they existed as of the date of this report. The
Partnership   undertakes  no  obligation  to  publicly   update  or  revise  any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.

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

      The Partnership offered limited  partnership  interests to the public from
December 1980 to December 1981 pursuant to a Registration  Statement filed under
the Securities Act of 1933.  Gross proceeds of $21,550,000  were received by the
Partnership   and,  after  deducting   selling   expenses  and  offering  costs,
approximately  $18,802,000 was originally  invested in six operating  investment
properties, comprised of three multi-family apartment complexes and three retail
shopping centers.  Through September 30, 1997, the three multi-family  apartment
properties have been sold, and the  Partnership  sold its interest in one of the
retail shopping centers to its co-venture partner during fiscal 1997. Of the two
remaining retail  properties,  one is owned through a joint venture  partnership
and one is owned directly and is subject to a master lease. As discussed further
below,  the  Partnership  also retains a subordinated  mortgage note  receivable
position related to two of the multi-family properties which were sold in fiscal
1985. At the present time, the  Partnership  does not have any  commitments  for
additional capital expenditures or investments but may be called upon to advance
funds to its  existing  investments  to pay for its  share of  certain  required
capital improvement expenses.

      On August 1, 1997,  the  Partnership  sold its  interest in the Pine Trail
Shopping  Center to its joint  venture  partner  for a net price of  $6,150,000.
Funds to complete this transaction were provided from a refinancing of the first
mortgage  debt  secured  by  the  Pine  Trail  property.  As a  result  of  this
transaction,  the Partnership made a special capital distribution to the Limited
Partners of $285.25 per original  $1,000  investment on September 15, 1997.  The
Partnership  no longer  holds an  interest  in this  property.  The net price of
$6,150,000 is the amount the Partnership  would have received from a third-party
sale at any sale price between  $13,800,000 and $18,500,000.  Under the terms of
the Pine Trail joint  venture  agreement,  the  Partnership  was entitled to the
first  $6,150,000  as a first  priority  from the net sale  proceeds  after  the
payment of closing costs and adjustments as well as the mortgage indebtedness of
approximately  $7,700,000.  Then the co-venture partner was entitled to the next
$4,156,000,  with any  remaining net sale proceeds  split  50%/50%.  Under these
terms,  the Partnership  would not receive any amount above $6,150,000 until the
sale  price  of the  property  exceeded  $18,500,000.  If a sale  price  of over
$18,500,000 were achieved, the Partnership and the co-venturer would have shared
equally in any excess over $18,500,000. Management believed that a sale price of
$18,500,000  was unlikely to be achieved for several years,  which was supported
by the most recent independent appraisal of Pine Trail which valued the property
at $16,250,000.  The net operating income from the Pine Trail Shopping Center is
not  expected to improve  significantly  for the next five years  because of the
long-term  leases and fixed  rental rates on the anchor and  out-parcel  leases,
which comprise 73% of the property's  total base rental income and nearly 82% of
the total net leasable  area.  One anchor's  lease term expires in January 2002,
two other anchor  leases  expire in November  2006,  and the fourth anchor lease
expires in January 2012. As a result of these circumstances, management believed
that  accepting the net sale price of $6,150,000 was in the  Partnership's  best
interests.

      With the sale of the Pine Trail investment, the Partnership is focusing on
potential  disposition  strategies  for its Central  Plaza and  Northeast  Plaza
properties.  As discussed  further  below,  the  Partnership  has been exploring
potential opportunities to sell Central Plaza, and there is a possibility that a
sale of the  property  could be  completed  in early  calendar  year  1998.  The
Partnership also expects to re-market the Northeast Plaza property for sale once
the lawsuit against Mobil Oil Corporation,  which is discussed further below, is
resolved. The sale of the Partnership's  remaining assets would be followed by a
liquidation of the Partnership.  It is currently  contemplated that sales of the
Partnership's  assets could be completed within the next 1 to 2 years. There are
no  assurances,  however,  that  the  sales  of the  remaining  assets  and  the
liquidation of the Partnership will be completed within this time frame.

      The Partnership and its co-venture  partner who own Central Plaza Shopping
Center engaged the services of a nationally  affiliated brokerage firm to market
this  property for sale during fiscal 1997.  The  property,  which is located in
Lubbock,  Texas, was marketed extensively and sales packages were distributed to
national,  regional  and  local  prospective  purchasers.  As a result  of these
efforts,  three  offers  were  received.  After  evaluating  the  offers and the
relative strength of the prospective  purchasers,  an offer was selected and the
Partnership and the  co-venturer  are currently  negotiating a purchase and sale
contract with the  prospective  buyer.  Although there are no assurances  that a
sale  transaction  will be completed,  it is possible that a sale could close in
early calendar year 1998.  The occupancy  level at Central Plaza remained at 92%
as of September 30, 1997,  unchanged from its level of a year ago. While none of
the Center's  leases expire until  January 1999,  there is 11,500 square feet of
vacant space that is available to lease.  As  previously  reported,  the largest
part of the vacant  space is  approximately  6,400  square feet which is next to
Best Buy, the Center's electronics anchor store. The property's leasing team has
recently  attracted interest in this space from a retailer that has locations in
the  Dallas  area and is  looking to open a store in the  Lubbock  market.  This
retailer is  interested  in occupying  4,000 of the 6,400  square  feet,  and an
existing  tenant is  working  with the  property's  leasing  team on a  possible
expansion of its store into the other 2,400 square feet.

      As previously reported, management believes that the Partnership's efforts
to sell or refinance the Northeast Plaza property have been impeded by potential
lender concerns of an environmental nature with respect to the property.  During
1990,  it was  discovered  that  certain  underground  storage  tanks at a Mobil
service  station  located  adjacent  to  the  shopping  center  had  leaked  and
contaminated  the ground water in the  vicinity of the  station.  Since the time
that the  contamination  was discovered,  Mobil has investigated the leak and is
progressing  with efforts to remediate  the soil and ground water  contamination
under the  supervision of the Florida  Department of  Environmental  Protection,
which has approved  Mobil's  remedial  action  plan.  During  fiscal  1990,  the
Partnership  had  obtained  a formal  indemnification  agreement  from Mobil Oil
Corporation  in which Mobil  agreed to bear the cost of all damages and required
clean-up expenses.  Furthermore,  Mobil indemnified the Partnership  against its
inability to sell,  transfer or obtain  financing on the property because of the
contamination. Subsequent to the discovery of the contamination, the Partnership
experienced difficulty in refinancing the mortgages on the property that matured
in  1991.  The  existence  of  contamination   on  the  property   impacted  the
Partnership's  ability to obtain  standard  market  financing.  Ultimately,  the
Partnership was able to refinance its first mortgage at a substantially  reduced
loan-to-value  ratio.  In  addition,  the  Partnership  was  unable  to sell the
property at an  uncontaminated  market  price.  The  Partnership  also  retained
outside  counsel and  environmental  consultants to review  Mobil's  remediation
efforts and has incurred significant  out-of-pocket  expenses in connection with
this situation.  Despite  repeated  requests by the Partnership for compensation
under the terms of the indemnification agreement, to date Mobil has disagreed as
to the  extent  of  the  indemnification  and  has  refused  to  compensate  the
Partnership for any of its damages.

      During the first  quarter of fiscal 1993,  the  Partnership  filed suit in
Federal  Court against  Mobil for breach of indemnity  and property  damage.  On
April 28, 1995,  Mobil was  successful in dismissing the action from the Federal
Court system on jurisdictional grounds.  Subsequently,  the Partnership filed an
action in the Florida State Court system.  On November 14, 1996, the state court
granted the  Partnership's  Motion for Partial Summary  Judgment as to liability
with  regard  to the  Partnership's  claims  for  damages  due to  trespass  and
nuisance.  By  obtaining  a  summary  judgment  of  liability  and  subsequently
defeating  Mobil's appeal of the summary  judgment,  the  Partnership has firmly
established  Mobil Oil  Corporation's  liability  for the  trespass and nuisance
caused by the  contamination.  The trial on these counts will focus  directly on
the damages  suffered by the Partnership.  In addition,  the trial court found a
reasonable  evidentiary basis for the Partnership to amend its complaint to seek
punitive  damages  against Mobil for certain  intentional  or grossly  negligent
conduct which caused the  contamination  of the Center.  The jury will determine
the Partnership's  entitlement to compensatory  and/or punitive damages, if any.
Finally,  the trial court  granted the  Partnership  leave to seek an injunction
against  Mobil to  force  them to  complete  the  cleanup  of the  Center  on an
expedited  basis. If the Partnership is successful at trial, the injunction will
likely advance the completion of the cleanup by several years.

      During  November 1996, the  Partnership  and Mobil attempted to settle the
action through  mediation.  A settlement was not achieved.  Mobil's  proposal to
settle the case, which included a proposed purchase of the contaminated  portion
of the  Northeast  Plaza  property from the  Partnership,  failed due to Mobil's
inability  to  obtain a zoning  variance  which  was  necessary  to make  such a
transaction  possible.  The matter is set for a jury trial  during the  two-week
period  commencing  April 6, 1998. The completion of discovery will occur during
the second quarter of fiscal 1998. The  Partnership is seeking damages in excess
of  $2,000,000.  It is  impossible  to determine at this time,  with  reasonable
certainty, the likely range of potential recovery, if any, by the Partnership.

      The Northeast  Plaza property,  which the  Partnership  master leases to a
local  manager/operator,  was 100% leased and occupied as of September 30, 1997.
During the first  quarter of fiscal 1997, a 10,000 square foot tenant closed its
store at the property;  however, the property's leasing team was able to replace
them with a new tenant,  an auto  supply  store,  that leased the entire  10,000
square feet for a five-year term. Additionally, five tenants that occupy a total
of 6,390 square feet signed lease  renewals  during the fiscal year. In calendar
year 1998, leases with 3 tenants  representing a total of 8,900 square feet come
up for renewal.

      At  September  30,  1997,  the  Partnership  had  available  cash and cash
equivalents of $973,000. Such cash and cash equivalents will be used for working
capital  requirements and  distributions  to the partners.  The source of future
liquidity  and  distributions  to the  partners is  expected to be through  cash
generated from the operations of the Partnership's  income-producing  investment
properties and proceeds received from the sale or refinancing of such properties
or sales of the  Partnership's  interests  in such  properties.  Such sources of
liquidity are expected to be sufficient to meet the Partnership's  needs on both
a short-term  and  long-term  basis.  In addition,  the  Partnership  has a note
receivable  that it received as a portion of the  proceeds  from the sale of its
interest in the  Briarwood  joint  venture in fiscal 1985.  The note and related
accrued  interest  receivable have been netted against a deferred gain of a like
amount  on the  accompanying  balance  sheet.  The  interest  owed  on the  note
receivable is currently  payable only to the extent that the related  properties
generate  excess net cash flow.  To date,  no payments have been received on the
note, and it is uncertain whether any will be received in the near future. Since
the  operating  properties  continue to generate net cash flow  deficits and the
Partnership's  note  receivable is  subordinated  to the existing first mortgage
debt, there is significant uncertainty as to the collectibility of the principal
and accrued interest.  Proceeds,  if any, received on the note would represent a
source of additional liquidity for the Partnership.

Results of Operations
1997 Compared to 1996
---------------------

      The  Partnership's  net income decreased by $2,704,000 during fiscal 1997,
when compared to the prior year.  The decrease in the  Partnership's  net income
for the current fiscal year is primarily the result of the  Partnership's  share
of the gain  from the sale of the  Camelot  Apartments  in  fiscal  1996,  which
totalled  $5,926,000.  During fiscal 1997,  the  Partnership  realized a gain of
$3,565,000  from the sale of its  interest in the Pine Trail joint  venture.  In
addition, the Partnership's share of ventures' income decreased by $293,000 when
compared  to the  prior  year.  The  Partnership's  share  of  ventures'  income
decreased due, in part, to the $151,000 of income  allocated to the  Partnership
from the  operations of the Camelot  Apartments in fiscal 1996 prior to the sale
of that property.  In addition,  the Partnership's  share of the net income from
the Central Plaza joint venture  decreased by $182,000 in fiscal 1997  primarily
due to  the  method  of  allocating  income  between  the  venture  partners  in
accordance  with the joint venture  agreement.  Income is allocated  between the
venture  partners in proportion to the cash  distributions  received  during the
year.  During fiscal 1996, the Partnership  received 100% of the  distributions,
whereas in fiscal 1997 the distributable  cash was split between the Partnership
and the co-venturer in a ratio of approximately 56% and 44%,  respectively.  The
Partnership's share of net income from the Pine Trail joint venture increased by
$35,000 in fiscal 1997,  despite not owning the interest for the last two months
of the year,  mainly as a result of a decrease  in  depreciation  expense due to
some assets having become fully depreciated during fiscal 1996.

      An  increase  in  the   Partnership's   operating  loss  of  $50,000  also
contributed  to the  decrease  in net  income in  fiscal  1997.  Operating  loss
increased due to an increase in general and administrative  expenses of $79,000.
General  and  administrative  expenses  increased  primarily  due  to a  $92,000
increase in legal fees as a result of the continued litigation against Mobil Oil
Corporation,  as  discussed  further  above.  The  increase  in  legal  fees was
partially  offset by an  increase  in  interest  income of $17,000 and a $12,000
decrease  in  interest  expense.  Interest  income  increased  due to the higher
average outstanding cash balances resulting from the temporary investment of the
Pine Trail  sale  proceeds  pending  the  special  distribution  to the  Limited
Partners which occurred on September 15, 1997.  Interest expense  decreased as a
result of the scheduled principal  amortization on the outstanding mortgage loan
payable.


<PAGE>


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

      The  Partnership's  net income increased by $6,278,000 during fiscal 1996,
when compared to the prior year. The substantial  increase in the  Partnership's
net income for fiscal 1996 was primarily the result of the  Partnership's  share
of the gain from the sale of the  Camelot  Apartments,  which  occurred  in June
1996. The gain recognized by the Camelot joint venture  totaled  $12,089,000 and
the  Partnership's  share  of  such  gain  amounted  to  $5,926,000,  net of the
write-off of the unamortized  balance of the  Partnership's  excess basis in the
Camelot joint venture of $1,506,000.  In addition,  the  Partnership's  share of
ventures' operating income increased by $186,000,  when compared to fiscal 1995.
The Partnership's share of ventures' operating income increased primarily due to
an increase in the portion of the income  allocated to the Partnership  from the
Central Plaza joint venture.  The joint venture's  income  allocation  primarily
follows the allocation of cash distributions. The Partnership was allocated 100%
of the cash  distributions  from Central Plaza during fiscal 1996 as compared to
approximately 60% of cash distributions during the prior year. While fiscal 1996
net income increased by only $65,000 at Central Plaza, the  Partnership's  share
of the  venture's  income  increased  by $224,000.  Net income at Central  Plaza
increased in fiscal 1996 primarily due to an increase in revenues resulting from
higher  average  rental  rates.  The  increase  in the  Partnership's  share  of
venture's  income  from  Central  Plaza was  partially  offset by a decrease  in
operating  income from the Camelot  Apartments  joint venture due to the sale of
the property on June 19, 1996.

      A  decrease  in  the   Partnership's   operating  loss  of  $166,000  also
contributed  to the  increase  in net  income in  fiscal  1996.  Operating  loss
decreased  due to an increase  in  interest  income of $70,000 and a decrease in
general and administrative expenses of $85,000. Interest income increased due to
the higher  average  outstanding  cash  balances  resulting  from the  temporary
investment of the Camelot sale proceeds pending the special  distribution to the
Limited Partners which occurred on August 15, 1996.  General and  administrative
expenses  decreased  primarily as a result of incremental  expenses  incurred in
fiscal 1995 relating to an independent valuation of the Partnership's  operating
properties.

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

      The Partnership's net income increased by $19,000 during fiscal 1995, when
compared to fiscal 1994, mainly due to an increase in the Partnership's share of
ventures'  income of $68,000  which was  partially  offset by an increase in the
general  and  administrative  expenses of  $51,000.  General and  administrative
expenses  increased  mainly due to increased legal and appraisal costs resulting
from the  continued  litigation  against  Mobil Oil  Corporation,  as  discussed
further above. The Partnership's  share of ventures' income increased  primarily
due to an increase in net income at the Pine Trail joint venture.  Net income at
Pine Trail  increased as a result of an increase in rental  income due to higher
average  occupancy levels when compared to fiscal 1994. The Pine Trails Shopping
Center had an average occupancy level of 96% for fiscal 1995, as compared to 93%
for fiscal 1994.  The  Partnership's  share of ventures'  income also  increased
because the Partnership was allocated a higher percentage of the net income from
the Camelot  joint  venture when  compared to fiscal  1994.  Although net income
decreased  slightly  at  Camelot  as a  result  of an  increase  in  maintenance
expenses,  the Partnership  was allocated a larger  percentage of the net income
due to the method of allocation  specified in the joint venture  agreement.  The
increase  in the  Partnership's  share of income from the Pine Trail and Camelot
joint ventures was partially offset by a decrease in the Partnership's  share of
income from Central Plaza. Net income was down at Central Plaza as a result of a
decline in average occupancy compared to fiscal 1994. Occupancy at Central Plaza
declined  from 96% for fiscal  1994 to 93% for fiscal 1995 mainly due to a 6,000
square  foot tenant that  vacated the  property in the second  quarter of fiscal
1995.

Certain Factors Affecting Future Operating Results
--------------------------------------------------

      The following factors could cause actual results to differ materially from
historical results or those anticipated:

      Real Estate  Investment  Risks.  Real property  investments are subject to
varying degrees of risk.  Revenues and property values may be adversely affected
by the  general  economic  climate,  the local  economic  climate and local real
estate conditions,  including (i) the perceptions of prospective  tenants of the
attractiveness of the property; (ii) the ability to retain qualified individuals
to provide  adequate  management  and  maintenance  of the  property;  (iii) the
inability  to  collect  rent due to  bankruptcy  or  insolvency  of  tenants  or
otherwise;  and (iv) increased  operating costs.  Real estate values may also be
adversely  affected by such  factors as  applicable  laws,  including  tax laws,
interest rate levels and the availability of financing.

      Effect of Uninsured Loss. The Partnership carries comprehensive liability,
fire,  flood,  extended  coverage and rental loss  insurance with respect to its
properties  with  insured  limits  and  policy  specifications  that  management
believes are customary for similar properties. There are, however, certain types
of  losses  (generally  of  a  catastrophic  nature  such  as  wars,  floods  or
earthquakes) which may be either uninsurable,  or, in management's judgment, not
economically  insurable.  Should an uninsured loss occur, the Partnership  could
lose both its  invested  capital in and  anticipated  profits  from the affected
property.

      Possible Environmental Liabilities. Under various federal, state and local
environmental laws,  ordinances and regulations,  a current or previous owner or
operator of real property may become liable for the costs of the  investigation,
removal and  remediation  of  hazardous or toxic  substances  on,  under,  in or
migrating from such property. Such laws often impose liability without regard to
whether the owner or operator knew of, or was  responsible  for, the presence of
such hazardous or toxic substances.

      Notwithstanding  the  environmental   situation  at  the  Northeast  Plaza
property  described  above,  the Partnership is not aware of any notification by
any private party or governmental authority of any non-compliance,  liability or
other claim in connection with environmental conditions at any of its properties
that it believes  will  involve any  expenditure  which would be material to the
Partnership,  nor is the Partnership aware of any  environmental  condition with
respect to any of its properties that it believes will involve any such material
expenditure.  However,  there  can  be no  assurance  that  any  non-compliance,
liability, claim or expenditure will not arise in the future.

      Competition. The financial performance of the Partnership's remaining real
estate  investments,  both  of  which  are  retail  shopping  centers,  will  be
significantly  impacted by the competition  from comparable  properties in their
local market  areas.  The  occupancy  levels and rental rates  achievable at the
properties  are  largely a function  of supply and  demand in the  markets.  The
retail  segment  of the  real  estate  market  is  currently  suffering  from an
oversupply of space in many markets  resulting from overbuilding in recent years
and the trend of consolidations and bankruptcies among retailers prompted by the
generally flat rate of growth in overall  retail sales.  There are no assurances
that these competitive pressures will not adversely affect the operations and/or
market values of the Partnership's investment properties in the future.

      Impact of Joint Venture  Structure.  The ownership of one of the remaining
investments  through a joint  venture  partnership  could  adversely  impact the
timing of the Partnership's  planned disposition of this asset and the amount of
proceeds received from such  disposition.  It is possible that the Partnership's
co-venture   partner  could  have  economic  or  business  interests  which  are
inconsistent with those of the Partnership.  Given the rights which both parties
have under the terms of the joint venture  agreement,  any conflict  between the
partners  could result in delays in  completing a sale of the related  operating
property and could lead to an impairment in the marketability of the property to
third parties for purposes of achieving the highest possible sale price.

      Availability of a Pool of Qualified Buyers.  The availability of a pool of
qualified  and  interested  buyers  for the  Partnership's  remaining  assets is
critical  to the  Partnership's  ability to realize  the  estimated  fair market
values of such  properties  at the time of their final  dispositions.  Demand by
buyers of retail  properties  is affected by many  factors,  including the size,
quality,  age,  condition and location of the subject property,  the quality and
stability of the tenant  roster,  the terms of any long-term  leases,  potential
environmental liability concerns, the existing debt structure,  the liquidity in
the debt and equity markets for asset acquisitions,  the general level of market
interest rates and the general and local economic climates.

Inflation
---------

      The Partnership  completed its sixteenth full year of operations in fiscal
1997 and the effects of inflation and changes in prices on revenues and expenses
to date have not been significant.

      Inflation in future  periods may increase  revenues,  as well as operating
expenses, at the Partnership's operating investment properties. The master lease
on the Partnership's  wholly-owned retail shopping center requires the lessee to
pay all of the expenses  associated  with  operating the property.  Furthermore,
many of the existing  leases with tenants at the  Partnership's  remaining joint
venture owned retail  shopping center contain rental  escalation  and/or expense
reimbursement  clauses based on increases in tenant sales or property  operating
expenses.  Such  increases  in  rental  income  would  be  expected  to at least
partially  offset  the  corresponding  increases  in  Partnership  and  property
operating expenses caused by future inflation.

Item 8.  Financial Statements and Supplementary Data

      The financial statements and supplementary data are included under Item 14
of this Annual Report.

Item 9. Changes in and  Disagreements  with  Accountants  on  Accounting  and
Financial Disclosure

      None.


<PAGE>

                                   PART III

Item 10.  Directors and Principal Executive Officers of the Partnership

      The General Partner of the Partnership is Third Income Properties, Inc., a
Delaware  corporation,  which is a wholly-owned  subsidiary of PaineWebber.  The
General Partner has overall authority and  responsibility  for the Partnership's
operations,  however,  the day-to-day  business of the Partnership is managed by
the Adviser pursuant to an advisory contract.

      (a) and (b) The names and ages of the directors  and  principal  executive
officers of the General Partner of the Partnership are as follows:
                                                                     Date
                                                                     elected
      Name                      Office                      Age      to Office
      ----                      ------                      ---      ---------

Bruce J. Rubin          President and Director              38        8/22/96
Terrence E. Fancher     Director                            44        10/10/96
Walter V. Arnold        Senior Vice President
                          and Chief Financial Officer       50        10/29/85
David F. Brooks         First Vice President and
                          Assistant Treasurer               55        6/13/80 *
Timothy J. Medlock      Vice President and Treasurer        36        6/1/88
Thomas W. Boland        Vice President and Controller       35        12/1/91

*  The date of incorporation of the General Partner

      (c) There are no other significant  employees in addition to the directors
and executive officers mentioned above.

      (d) There is no family  relationship among any of the foregoing  directors
or officers  of the General  Partner of the  Partnership.  All of the  foregoing
directors  and  executive  officers  have been elected to serve until the annual
meeting of the General Partner.

      (e) All of the directors and officers of the General  Partner hold similar
positions in affiliates of the General Partner,  which are the corporate general
partners of other real estate  limited  partnerships  sponsored  by PWI, and for
which Paine Webber Properties  Incorporated serves as the Adviser.  The business
experience  of each of the directors  and  principal  executive  officers of the
General Partner is as follows:

      Bruce J. Rubin is  President  and Director of the General  Partner.  Mr.
Rubin  was  named  President  and Chief  Executive  Officer  of PWPI in August
1996.  Mr.  Rubin  joined   PaineWebber  Real  Estate  Investment  Banking  in
November 1995 as a Senior Vice President.  Prior to joining  PaineWebber,  Mr.
Rubin was employed by Kidder,  Peabody and served as  President  for KP Realty
Advisers,  Inc. Prior to his association  with Kidder,  Mr. Rubin was a Senior
Vice President and Director of Direct  Investments  at Smith Barney  Shearson.
Prior thereto,  Mr. Rubin was a First Vice President and a real estate workout
specialist  at Shearson  Lehman  Brothers.  Prior to joining  Shearson  Lehman
Brothers in 1989, Mr. Rubin  practiced law in the Real Estate Group at Willkie
Farr  &  Gallagher.  Mr.  Rubin  is a  graduate  of  Stanford  University  and
Stanford Law School.


<PAGE>


      Terrence E.  Fancher was  appointed a Director of the  Managing  General
Partner in October  1996.  Mr.  Fancher is the Managing  Director in charge of
PaineWebber's  Real Estate Investment  Banking Group. He joined PaineWebber as
a result  of the  firm's  acquisition  of  Kidder,  Peabody.  Mr.  Fancher  is
responsible  for the origination  and execution of all of  PaineWebber's  REIT
transactions,  advisory assignments for real estate clients and certain of the
firm's real estate debt and principal  activities.  He joined Kidder,  Peabody
in 1985 and,  beginning in 1989, was one of the senior executives  responsible
for  building   Kidder,   Peabody's  real  estate   department.   Mr.  Fancher
previously  worked for a major law firm in New York City.  He has a J.D.  from
Harvard  Law  School,  an M.B.A.  from  Harvard  Graduate  School of  Business
Administration and an A.B. from Harvard College.

      Walter V. Arnold is a Senior Vice President and Chief Financial Officer of
the General Partner and Senior Vice President and Chief Financial Officer of the
Adviser which he joined in October 1985.  Mr. Arnold joined PWI in 1983 with the
acquisition  of Rotan Mosle,  Inc.  where he had been First Vice  President  and
Controller  since 1978,  and where he continued  until joining the Adviser.  Mr.
Arnold is a Certified Public Accountant licensed in the state of Texas.

      David F. Brooks is a First Vice  President and Assistant  Treasurer of the
General  Partner and a First Vice  President  and an Assistant  Treasurer of the
Adviser.  Mr.  Brooks joined the Adviser in March 1980.  From 1972 to 1980,  Mr.
Brooks was an Assistant  Treasurer of Property Capital Advisors,  Inc. and also,
from March 1974 to February  1980,  the Assistant  Treasurer of Capital for Real
Estate,  which provided real estate investment,  asset management and consulting
services.

      Timothy J.  Medlock  is a Vice  President  and  Treasurer  of the  General
Partner and Vice President and Treasurer of the Adviser which he joined in 1986.
From June 1988 to August  1989,  Mr.  Medlock  served as the  Controller  of the
General  Partner and the Adviser.  From 1983 to 1986, Mr. Medlock was associated
with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate  University in
1983 and received his Masters in Accounting from New York University in 1985.

      Thomas W.  Boland is a Vice  President  and  Controller  of the  General
Partner and a Vice  President and Controller of the Adviser which he joined in
1988.  From 1984 to 1987,  Mr.  Boland  was  associated  with  Arthur  Young &
Company.  Mr. Boland is a Certified  Public  Accountant  licensed in the state
of  Massachusetts.  He holds a B.S. in Accounting  from Merrimack  College and
an M.B.A. from Boston University.

      (f) None of the directors and officers were involved in legal  proceedings
which are  material to an  evaluation  of her or his ability or  integrity  as a
director or officer.

      (g)  Compliance  With  Exchange Act Filing  Requirements:  The  Securities
Exchange Act of 1934 requires the officers and directors of the Managing General
Partner, and persons who own more than ten percent of the Partnership's  limited
partnership units, to file certain reports of ownership and changes in ownership
with the Securities and Exchange Commission. Officers, directors and ten-percent
beneficial  holders are required by SEC  regulations to furnish the  Partnership
with copies of all Section 16(a) forms they file.

      Based solely on its review of the copies of such forms received by it, the
Partnership  believes that, during the year ended September 30, 1997, all filing
requirements  applicable to the officers and  directors of the Managing  General
Partner and ten-percent beneficial holders were complied with.

Item 11.  Executive Compensation

      The directors and officers of the Partnership's General Partner receive no
current or  proposed  remuneration  from the  Partnership.  The  Partnership  is
required to pay  certain  fees to the  Adviser,  and the  General  Partners  are
entitled  to  receive a share of cash  distributions  and a share of  profits or
losses. These items are described under Item 13.

      The  Partnership  has paid  cash  distributions  to the  Unitholders  on a
quarterly  basis at rates ranging from 3% to 6% per annum on remaining  invested
capital over the past five years.  However,  the Partnership's  Units of Limited
Partnership  Interest are not actively traded on any organized exchange,  and no
efficient secondary market exists. Accordingly, no accurate price information is
available for these Units.  Therefore,  a presentation of historical  Unitholder
total returns would not be meaningful.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

      (a) The  Partnership  is a limited  partnership  issuing  Units of limited
partnership  interest,  not voting securities.  All the outstanding stock of the
General  Partner,  Third Income  Properties,  Inc. is owned by  PaineWebber.  No
limited partner is known by the Partnership to own beneficially  more than 5% of
the outstanding interests of the Partnership.

      (b) Neither  officers and directors of the General Partner nor the general
partners  of the  Associate  General  Partner,  individually,  own any  Units of
limited partnership  interest of the Partnership.  No director or officer of the
General Partner,  possesses a right to acquire beneficial  ownership of Units of
limited partnership interest of the Partnership.

      (c) There exists no arrangement,  known to the Partnership,  the operation
of  which  may at a  subsequent  date  result  in a  change  in  control  of the
Partnership.

Item 13.  Certain Relationships and Related Transactions

      The General  Partner of the Partnership is Third Income  Properties,  Inc.
(the "General  Partner"),  a wholly-owned  subsidiary of PaineWebber Group, Inc.
("PaineWebber").  Subject  to  the  General  Partner's  overall  authority,  the
business of the  Partnership is managed by PaineWebber  Properties  Incorporated
(the "Adviser") pursuant to an advisory contract.  The Adviser is a wholly-owned
subsidiary of PaineWebber  Incorporated  ("PWI"),  a wholly-owned  subsidiary of
PaineWebber.  The  General  Partner,  the  Adviser  and  PWI  receive  fees  and
compensation,  determined on an agreed-upon  basis, in  consideration of various
services  performed in connection with the sale of the Units,  the management of
the Partnership and the  acquisition,  management,  financing and disposition of
Partnership investments.

      In connection with investing  Partnership  Capital,  the Adviser  received
acquisition fees of 9% of the gross proceeds from the sale of Partnership Units.
In  connection  with  the sale of each  property,  the  Adviser  may  receive  a
disposition fee, payable upon liquidation of the Partnership, in an amount equal
to 3/4% of the selling  price of the  property,  subordinated  to the payment of
certain amounts to the Limited Partners.

      All  distributable  cash, as defined,  for each fiscal year is distributed
quarterly  in the ratio of 99% to the  Limited  Partners  and 1% to the  General
Partner.  All sale or  refinancing  proceeds  shall be  distributed  in  varying
proportions to the Limited and General Partners, as specified in the Partnership
Agreement. In accordance with the Partnership Agreement, the General Partner has
not received any sale or refinancing proceeds to date.

      Pursuant to the terms of the Partnership Agreement,  taxable income or tax
loss from  operations  of the  Partnership  will be allocated 99% to the Limited
Partners and 1% to the General Partner.  Taxable income or tax loss arising from
a sale or refinancing of investment  properties will be allocated to the Limited
Partners  and the  General  Partner  in  proportion  to the  amounts  of sale or
refinancing  proceeds  to which  they are  entitled  provided  that the  General
Partner will be allocated at least 1% of taxable  income  arising from a sale or
refinancing. If there are no sale or refinancing proceeds, taxable income or tax
loss from a sale or  refinancing  will be allocated 99% to the Limited  Partners
and 1% to the  General  Partner.  Allocations  of the  Partnership's  operations
between the General  Partner and the Limited  Partners for financial  accounting
purposes have been made in conformity  with the allocations of taxable income or
tax loss.

      Under  the  advisory  contract,   the  Adviser  has  specific   management
responsibilities:  to administer the day-to-day  operations of the  Partnership,
and to report  periodically  the  performance of the  Partnership to the General
Partners.  The Adviser is paid a basic management fee (4% of Adjusted Cash Flow,
as  defined)  and  an  incentive  management  fee  (5%  of  Adjusted  Cash  Flow
subordinated to a noncumulative  annual return to the Limited  Partners equal to
6% based upon their adjusted capital  contribution) for services  rendered.  The
Adviser earned basic management fees of $17,000 for the year ended September 30,
1997. No incentive  management  fees were earned during the year ended September
30, 1997.

      An affiliate  of the General  Partner  performs  certain  accounting,  tax
preparation, securities law compliance and investor communications and relations
services  for the  Partnership.  The total costs  incurred by this  affiliate in
providing  such  services  allocated  among  several  entities,   including  the
Partnership.  Included in general and administrative expenses for the year ended
September 30, 1997 is $67,000, representing reimbursements to this affiliate for
providing such services to the Partnership.

      The  Partnership  uses the  services  of Mitchell  Hutchins  Institutional
Investors,  Inc. ("Mitchell Hutchins") for the managing of cash assets. Mitchell
Hutchins is a  subsidiary  of  Mitchell  Hutchins  Asset  Management,  Inc.,  an
independently operated subsidiary of PaineWebber.  Mitchell Hutchins earned fees
of $7,000  (included in general and  administrative  expenses)  for managing the
Partnership's  cash assets during fiscal 1997. Fees charged by Mitchell Hutchins
are based on a percentage of invested  cash  reserves  which varies based on the
total amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.





<PAGE>

                                    PART IV



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

   (a) The following documents are filed as part of this report:

        (1) and (2)     Financial Statements and Schedules:

                  The  response  to this  portion of Item 14 is  submitted  as a
                  separate  section  of this  report.  See  Index  to  Financial
                  Statements at page F-1.

        (3)  Exhibits:

                  The exhibits listed on the  accompanying  index to exhibits at
                  page IV-3 are filed as part of this report.

   (b)  A Current  Report on Form 8-K dated  August 1, 1997 was filed during the
        last  quarter  of fiscal  1997 to report  the sale of the  Partnership's
        joint  venture  interest  in the Pine  Trail  Partnership  and is hereby
        incorporated by reference.


   (c)  Exhibits

             See (a) (3) above.

   (d)  Financial Statement Schedules

             See (a) (1) and (2) above.
























                                    

<PAGE>


                                  SIGNATURES


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

                                      PAINE WEBBER INCOME PROPERTIES
                                      THREE LIMITED PARTNERSHIP



                                      By:  Third Income Properties, Inc.
                                           General Partner



                                  By: /s/ Bruce J. Rubin
                                      ------------------
                                      Bruce J. Rubin
                                      President and Chief Executive Officer



                                  By: /s/ Walter V. Arnold
                                      ------------------
                                      Walter V. Arnold
                                      Senior Vice President and
                                      Chief Financial Officer



                                  By: /s/ Thomas W. Boland
                                      ------------------
                                      Thomas W. Boland
                                      Vice President and Controller

Dated:  January 13, 1998

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  Partnership in
the capacity and on the dates indicated.




By:/s/ Bruce J. Rubin                           Date: January 13, 1998
   -----------------------                            ----------------
   Bruce J. Rubin
   Director



By:/s/ Terrence E. Fancher                      Date: January 13, 1998
   -----------------------                            ----------------
   Terrence E. Fancher
   Director


<PAGE>


                          ANNUAL REPORT ON FORM 10-K
                                 Item 14(a)(3)

               PAINE WEBBER PROPERTIES THREE LIMITED PARTNERSHIP


                               INDEX TO EXHIBITS
<TABLE>
<CAPTION>
                                                      Page Number in the Report
Exhibit No. Description of Document                   or Other Reference
----------- ------------------------                  -------------------------
<S>         <C>                                        <C>
(3) and (4) Prospectus of the Registrant              Filed with  the Commission
            dated December 3, 1980, supplemented,     pursuant to Rule 424(c)
            with particular reference to the          and incorporated  herein by
            Restated Certificate and Agreement        reference.
            Limited Partnership.


(10)        Material contracts previously filed as    Filed with the Commission
            exhibits to registration statements and   pursuant to Section 13 or 15(d)
            amendments thereto of the registrant      of  the  Securities Exchange Act
            together with all such contracts filed    of 1934 and incorporated
            as exhibits of previously filed Forms     herein by reference.
            8-K and Forms 10-K are hereby
            incorporated herein by reference.


(13)        Annual Reports to Limited Partners        No Annual Report for the year
                                                      ended September 30, 1997 has
                                                      been  sent to  the Limited Partners.
                                                      An  Annual Report  will be sent to 
                                                      the Limited Partners subsequent to
                                                      this filing.


(21)        List of Subsidiaries                      Included in Item 1 of Part I of this
                                                      Report Page I-1,  to which reference  
                                                      is hereby made.

(27)        Financial Data Schedule                   Filed as last page of EDGAR
                                                      submission following the Financial
                                                      Statements and Financial
                                                      Statement Schedule required by
                                                      Item 14.

</TABLE>
<PAGE>

                          ANNUAL REPORT ON FORM 10-K

                       Item 14(a) (1) and (2) and 14(d)

           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

       INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

                                                                     Reference
                                                                     ---------

Paine Webber Income Properties Three Limited Partnership:

    Report of independent auditors - Ernst & Young LLP                  F-2

    Report of independent accountants - Coopers & Lybrand L.L.P.        F-3

    Balance sheets at September 30, 1997 and 1996                       F-4

    Statements of income for the years ended September 30, 1997, 
     1996 and 1995                                                      F-5

    Statements of changes in partners' capital (deficit) for the 
     years ended  September 30, 1997, 1996 and 1995                     F-6

    Statements of cash flows for the years ended  September 30, 1997,
     1996 and 1995                                                      F-7

    Notes to financial statements                                       F-8

    Schedule III - Real Estate and Accumulated Depreciation             F-18

Combined  Joint  Ventures  of  PaineWebber  Income  Properties  Three  Limited
Partnership

    Report of independent auditors - Ernst & Young LLP                  F-19

    Report of independent accountants - Coopers & Lybrand L.L.P.        F-20

    Combined balance sheets as of September 30, 1997 and 1996           F-21

    Combined  statements of income and changes in venturers' 
     capital (deficit)for the years ended September 30, 1997, 1996 
     and 1995                                                           F-22

    Combined  statements of cash flows for the years ended 
     September 30, 1997, 1996 and 1995                                  F-23

    Notes to combined financial statements                              F-24

    Schedule III - Real Estate and Accumulated Depreciation             F-29

Other  schedules  have  been  omitted  since  the  required  information  is not
applicable,  or because the  information  required is included in the  financial
statements, including the notes thereto.




<PAGE>



                       REPORT OF INDEPENDENT AUDITORS




The Partners of
Paine Webber Income Properties Three Limited Partnership:

    We have  audited the  accompanying  balance  sheets of Paine  Webber  Income
Properties Three Limited  Partnership as of September 30, 1997 and 1996, and the
related statements of income,  changes in partners' capital (deficit),  and cash
flows for each of the three years in the period ended  September  30, 1997.  Our
audits also included the  financial  statement  schedule  listed in the Index at
Item 14(a).  These financial  statements and schedule are the  responsibility of
the  Partnership's  management.  Our  responsibility is to express an opinion on
these  financial  statements  and schedule  based on our audits.  The  financial
statements of Camelot  Associates (a partnership in which the  Partnership had a
50%  interest),  have been  audited  by other  auditors  whose  report  has been
furnished to us; insofar as our opinion on the financial  statements  relates to
data included for Camelot Associates, it is based solely on their report. In the
financial statements, the Partnership's share of the venture's income of Camelot
Associates is stated at $190,000 and $292,000 for the years ended  September 30,
1996 and  1995,  respectively,  and the  Partnership's  share of gain on sale of
operating  investment  property  is  stated  at  $7,432,000  for the year  ended
September 30, 1996.

    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 and the report of other auditors provide a reasonable
basis for our opinion.

    In our opinion,  based on our audits and the report of other  auditors,  the
financial statements referred to above present fairly, in all material respects,
the  financial   position  of  Paine  Webber  Income  Properties  Three  Limited
Partnership  at September 30, 1997 and 1996,  and the results of its  operations
and its cash flows for each of the three years in the period ended September 30,
1997, in conformity with generally accepted accounting principles.  Also, in our
opinion,  the related financial statement schedule,  when considered in relation
to the  basic  financial  statements  taken as a whole,  presents  fairly in all
material respects the information set forth therein.





                                              /s/ Ernst & Young LLP
                                              ---------------------
                                              ERNST & YOUNG LLP







Boston, Massachusetts
December 20, 1997



<PAGE>


                      Report of Independent Accountants



To the Venturers of
Camelot Associates:

    We have audited the  accompanying  balance sheets of Camelot  Associates (an
Ohio  Partnership)  as of June 19, 1996 and September 30, 1995,  and the related
statements of income,  venturers'  deficit and cash flows for the period October
1,  1995 to June  19,  1996 and for each of the two  years in the  period  ended
September 30, 1995.  These financial  statements are the  responsibility  of the
Partnership's  management.  Our responsibility is to express an opinion on these
financial statements 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 Camelot Associates (an Ohio
Partnership)  as of June 19, 1996 and September 30, 1995, and the results of its
operations  and its cash flows for the period  October 1, 1995 to June 19,  1996
and for  each of the two  years in the  period  ended  September  30,  1995,  in
conformity with generally accepted accounting principles.

    As described in Note 1, the  partnership  sold its  operating  properties in
1996.




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






Cincinnati, Ohio
January 10, 1997


<PAGE>


           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                                BALANCE SHEETS
                         September 30, 1997 and 1996
                   (In thousands, except per Unit amounts)

                                    ASSETS
                                                             1997       1996
                                                             ----       ----

Operating investment property, at cost:
   Land                                                 $     950    $    950
   Building and improvements                                4,088       4,088
                                                        ---------    --------
                                                            5,038       5,038
   Less accumulated depreciation                           (1,491)     (1,389)
                                                        ---------    --------
      Net operating investment property                     3,547       3,649

Investments in joint ventures, at equity                      215       2,844

Cash and cash equivalents                                     973       1,000
Accounts receivable                                             -          99
Deferred expenses, net of accumulated amortization
   of $74 ($53 in 1996)                                        32          53
Note and interest receivable, net                               -           -
                                                        ---------    --------
                                                        $   4,767    $  7,645
                                                        =========    ========

                      LIABILITIES AND PARTNERS' CAPITAL


Accounts payable - affiliates                           $       4    $      4
Accrued expenses                                               58          60
Mortgage note payable                                       1,278       1,420
                                                        ---------    --------
      Total liabilities                                     1,340       1,484


Partners' capital:
  General Partner:
   Capital contribution                                         1           1
   Cumulative net income                                      184         146
   Cumulative cash distributions                             (152)       (147)

  Limited Partners ($1,000 per Unit; 21,550 Units issued):
   Capital contributions, net of offering costs            19,397      19,397
   Cumulative net income                                   18,308      14,508
   Cumulative cash distributions                          (34,311)    (27,744)
                                                         --------    --------
      Total partners' capital                               3,427       6,161
                                                         --------    --------
                                                         $  4,767    $  7,645
                                                         ========    ========








                           See accompanying notes.


<PAGE>


           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                             STATEMENTS OF INCOME
            For the years ended September 30, 1997, 1996 and 1995
                   (In thousands, except per Unit amounts)


                                                1997         1996       1995
                                                ----         ----       ----
Revenues:
   Rental revenues                            $   478     $   478      $  478
   Interest and other income                      101          84          14
                                              -------     -------      ------
                                                  579         562         492

Expenses:
   Interest expense                               143         155         166
   Management fees                                 17          17          17
   Depreciation expense                           102         102         102
   General and administrative                     447         368         453
                                              -------     -------      ------
                                                  709         642         738
                                              -------     -------      ------

Operating loss                                   (130)        (80)       (246)

Partnership's share of ventures' income           403         696         510

Gain on sale of joint venture interest
  (net of write-off of unamortized excess
  basis of $50)                                 3,565           -           -

Partnership's share of gain on sale of
  operating investment property (net of 
  write-off of unamortized excess basis 
  of $1,506)                                        -       5,926           -
                                              -------     -------      ------

Net income                                    $ 3,838     $ 6,542      $  264
                                              =======     =======      ======


Net income per Limited Partnership Unit       $176.32     $300.56      $12.14
                                              =======     =======      ======

Cash distributions per Limited 
  Partnership Unit                            $304.77     $275.40      $19.40
                                              =======     =======      ======


   The above net income and cash distributions per Limited  Partnership Unit are
based upon the 21,550 Limited Partnership Units outstanding during each year.












                           See accompanying notes.


<PAGE>


            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

              STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
              For the years ended September 30, 1997, 1996 and 1995
                                 (In thousands)

                                         General     Limited
                                         Partner     Partners       Total
                                         -------     --------       -----


Balance at September 30, 1994            $  (59)     $5,775         $5,716

Cash distributions                           (4)       (418)          (422)

Net income                                    2         262            264
                                         ------      ------         ------

Balance at September 30, 1995               (61)      5,619          5,558

Cash distributions                           (4)     (5,935)        (5,939)

Net income                                   65       6,477          6,542
                                         ------      ------         ------

Balance at September 30, 1996                 -       6,161          6,161

Cash distributions                           (5)     (6,567)        (6,572)

Net income                                   38       3,800          3,838
                                         ------      ------         ------

Balance at September 30, 1997            $   33      $3,394         $3,427
                                         ======      ======         ======


























                           See accompanying notes.


<PAGE>


            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                            STATEMENTS OF CASH FLOWS
              For the years ended September 30, 1997, 1996 and 1995
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)

                                                1997        1996        1995
                                                ----        ----        ----
Cash flows from operating activities:
   Net income                                 $ 3,838     $ 6,542     $   264
   Adjustments to reconcile net income
    to net cash provided by (used in) 
    operating activities:
      Depreciation                                102         102         102
      Amortization of deferred financing
       costs                                       21          21          21
      Partnership's share of ventures' income    (403)       (696)       (510)
      Gain on sale of joint venture interest   (3,565)          -           -
      Partnership's share of gain on sale
        of operating investment property            -      (5,926)          -
      Changes in assets and liabilities:
         Accounts receivable                       99           -           -
         Accrued expenses                          (2)         20          (2)
                                              -------     -------     -------
           Total adjustments                   (3,748)     (6,479)       (389)
                                              -------     -------     -------
           Net cash provided by (used in) 
             operating activities                  90          63        (125)

Cash flows from investing activities:
   Proceeds from sale of joint venture
     interest                                   6,150           -           -
   Distributions from joint ventures              447       6,709         745
                                              -------     -------     -------
           Net cash provided by 
             investing activities               6,597       6,709         745
                                              -------     -------     -------
Cash flows from financing activities:
   Distributions to partners                   (6,572)     (5,939)       (422)
   Principal payments on mortgage note
     payable                                     (142)       (129)       (118)
                                              -------     -------     -------
           Net cash used in financing 
             activities                        (6,714)     (6,068)       (540)
                                              -------     -------     -------
Net (decrease) increase in cash and 
  cash equivalents                                (27)        704          80

Cash and cash equivalents, beginning of year    1,000         296         216
                                              -------     -------     -------
Cash and cash equivalents, end of year        $   973     $ 1,000     $   296
                                              =======     =======     =======

Cash paid during the year for interest        $   122     $   134     $   145
                                              =======     =======     =======













                            See accompanying notes.


<PAGE>

           PAINEWEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
                        Notes to Financial Statements


1.  Organization and Nature of Operations
    -------------------------------------

      Paine  Webber   Income   Properties   Three   Limited   Partnership   (the
"Partnership") is a limited  partnership  organized  pursuant to the laws of the
State of  Delaware in June 1980 for the purpose of  investing  in a  diversified
portfolio  of  income-producing   properties.  The  Partnership  authorized  the
issuance of units (the "Units") of partnership interests (at $1,000 per Unit) of
which  21,550  Units were  subscribed  and issued  between  December 3, 1980 and
December 10, 1981.

      The  Partnership  originally  invested  the  net  proceeds  of the  public
offering,  either  directly  or  through  joint  venture  partnerships,  in  six
operating  properties,  comprised of three multi-family  apartment complexes and
three  retail  shopping   centers.   Through   September  30,  1997,  the  three
multi-family apartment properties have been sold, and the Partnership's interest
in one of the retail shopping  centers was sold during fiscal 1997 (see Note 5).
Of the two  remaining  retail  properties,  one is owned through a joint venture
partnership  and one is owned  directly  and is subject to a master  lease.  See
Notes 4 and 5 for a  further  discussion  of the  Partnership's  remaining  real
estate investments.

2.  Use of Estimates and Summary of Significant Accounting Policies
    ---------------------------------------------------------------

      The  accompanying  financial  statements have been prepared on the accrual
basis of accounting in accordance with generally accepted accounting  principles
which require  management  to make  estimates  and  assumptions  that affect the
reported amounts of assets and liabilities and disclosures of contingent  assets
and  liabilities as of September 30, 1997 and 1996 and revenues and expenses for
each of the three years in the period ended  September 30, 1997.  Actual results
could differ from the estimates and assumptions used.

      The   accompanying   financial   statements   include  the   Partnership's
investments   in  certain  joint  venture   partnerships   which  own  operating
properties.  The  Partnership  accounts  for its  investments  in joint  venture
partnerships  using the equity method  because the  Partnership  does not have a
voting control interest in the ventures.  Under the equity method the investment
in a joint  venture is carried at cost adjusted for the  Partnership's  share of
the venture's earnings or losses and distributions. See Note 5 for a description
of the joint venture partnerships.

      The  Partnership  deferred  a  portion  of the  gain  on the  sale  of the
Briarwood Joint Venture  property in fiscal 1985 using the cost recovery method.
The portion of the remaining  gain to be recognized is represented by a note and
accrued interest receivable.  The note and accrued interest receivable have been
netted against the deferred gain on the  accompanying  balance  sheet.  The gain
would be recognized if the note and interest receivable are paid (see Note 6).

      The Partnership carries its operating investment property at cost, reduced
by  accumulated  depreciation,  or an amount  less than  cost if  indicators  of
impairment  are present in  accordance  with  Statement of Financial  Accounting
Standards  (SFAS) No. 121,  "Accounting for the Impairment of Long-Lived  Assets
and for Long-Lived  Assets to Be Disposed Of," which was adopted in fiscal 1997.
SFAS 121 requires  impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the  undiscounted  cash
flows  estimated  to be  generated  by those  assets  are less  than the  assets
carrying amount. The Partnership  generally assesses indicators of impairment by
a review of independent  appraisal reports on the operating investment property.
Such  appraisals  make  use  of a  combination  of  certain  generally  accepted
valuation techniques, including direct capitalization, discounted cash flows and
comparable sales analysis. Depreciation on the operating investment property has
been provided on the straight-line method based upon an estimated useful life of
40 years for the building and improvements.

      The Partnership's  wholly-owned  operating  investment  property is leased
under a master lease  agreement  which covers 100% of the rentable  space of the
shopping center.  The master lease is accounted for as an operating lease in the
Partnership's  financial statements.  Basic rental income under the master lease
is recorded on the straight-line basis.

      For purposes of reporting cash flows, the Partnership considers all highly
liquid  investments  with  original  maturities  of 90  days  or less to be cash
equivalents.

      The cash and cash equivalents appearing on the accompanying balance sheets
represent   financial   instruments  for  purposes  of  Statement  of  Financial
Accounting  Standards  No.  107,  "Disclosures  about  Fair  Value of  Financial
Instruments."   The  carrying   amount  of  these  cash  and  cash   equivalents
approximates  their  fair  value as of  September  30,  1997 and 1996 due to the
short-term maturities of these instruments.  The mortgage note payable is also a
financial  instrument  for  purposes of SFAS 107. The fair value of the mortgage
note payable is  estimated  using  discounted  cash flow  analysis  based on the
current  market rate for a similar  type of borrowing  arrangement.  Information
regarding the fair value of the Partnership's  mortgage note payable is provided
in Note 7.

      No  provision  for income  taxes has been made as the  liability  for such
taxes is that of the partners rather than the Partnership.

3.  The Partnership Agreement and Related Party Transactions
    --------------------------------------------------------

      The General  Partner of the Partnership is Third Income  Properties,  Inc.
(the "General  Partner"),  a wholly-owned  subsidiary of PaineWebber Group, Inc.
("PaineWebber").  Subject  to  the  General  Partner's  overall  authority,  the
business of the  Partnership is managed by PaineWebber  Properties  Incorporated
(the "Adviser") pursuant to an advisory contract.  The Adviser is a wholly-owned
subsidiary of PaineWebber  Incorporated  ("PWI"),  a wholly-owned  subsidiary of
PaineWebber.  The  General  Partner,  the  Adviser  and  PWI  receive  fees  and
compensation,  determined on an agreed-upon  basis, in  consideration of various
services  performed in connection with the sale of the Units,  the management of
the Partnership and the  acquisition,  management,  financing and disposition of
Partnership investments.

      In connection with investing  Partnership  Capital,  the Adviser  received
acquisition fees of 9% of the gross proceeds from the sale of Partnership Units.
In  connection  with  the sale of each  property,  the  Adviser  may  receive  a
disposition fee, payable upon liquidation of the Partnership, in an amount equal
to 3/4% of the selling  price of the  property,  subordinated  to the payment of
certain amounts to the Limited Partners.

      All  distributable  cash, as defined,  for each fiscal year is distributed
quarterly  in the ratio of 99% to the  Limited  Partners  and 1% to the  General
Partner.  All sale or  refinancing  proceeds  shall be  distributed  in  varying
proportions to the Limited and General Partners, as specified in the Partnership
Agreement. In accordance with the Partnership Agreement, the General Partner has
not received any sale or refinancing proceeds to date.

      Pursuant to the terms of the Partnership Agreement,  taxable income or tax
loss from  operations  of the  Partnership  will be allocated 99% to the Limited
Partners and 1% to the General Partner.  Taxable income or tax loss arising from
a sale or refinancing of investment  properties will be allocated to the Limited
Partners  and the  General  Partner  in  proportion  to the  amounts  of sale or
refinancing  proceeds  to which  they are  entitled  provided  that the  General
Partner will be allocated at least 1% of taxable  income  arising from a sale or
refinancing. If there are no sale or refinancing proceeds, taxable income or tax
loss from a sale or  refinancing  will be allocated 99% to the Limited  Partners
and 1% to the  General  Partner.  Allocations  of the  Partnership's  operations
between the General  Partner and the Limited  Partners for financial  accounting
purposes have been made in conformity  with the allocations of taxable income or
tax loss.

      Under  the  advisory  contract,   the  Adviser  has  specific   management
responsibilities:  to administer the day-to-day  operations of the  Partnership,
and to report  periodically  the  performance of the  Partnership to the General
Partners. The Adviser earns a basic management fee (4% of Adjusted Cash Flow, as
defined) and an incentive  management fee (5% of Adjusted Cash Flow subordinated
to a non-cumulative annual return to the Limited Partners equal to 6% based upon
their adjusted capital  contribution) for services rendered.  The Adviser earned
basic management fees of $17,000 for each of the three years ended September 30,
1997,  1996 and 1995.  No  incentive  management  fees were  earned  during  the
three-year  period ended  September 30, 1997.  Accounts  payable - affiliates at
both  September  30, 1997 and 1996  consists of  management  fees payable to the
Adviser of $4,000.

      Included  in  general  and  administrative  expenses  for the years  ended
September 30, 1997, 1996 and 1995 is $67,000, $68,000 and $72,000, respectively,
representing reimbursements to an affiliate of the General Partner for providing
certain  financial,  accounting  and  investor  communication  services  to  the
Partnership.

      The  Partnership  uses the  services  of Mitchell  Hutchins  Institutional
Investors,  Inc. ("Mitchell Hutchins") for the managing of cash assets. Mitchell
Hutchins is a  subsidiary  of  Mitchell  Hutchins  Asset  Management,  Inc.,  an
independently operated subsidiary of PaineWebber.  Mitchell Hutchins earned fees
of $7,000,  $2,000 and $2,000 (included in general and administrative  expenses)
for managing the  Partnership's  cash assets during fiscal 1997,  1996 and 1995,
respectively.

4.  Operating Investment Property
    -----------------------------

      The Partnership has one wholly-owned  operating  investment  property.  On
September 25, 1981, the Partnership  purchased  Northeast Plaza, a 67,000 square
foot  existing  shopping  center  in  Sarasota,   Florida.   Subsequent  to  the
acquisition,  the  shopping  center was  expanded to its current size of 121,005
square feet. The aggregate cash invested by the  Partnership  was  approximately
$2,888,000  (including an acquisition fee of $268,000 paid to the Adviser).  The
property was acquired  subject to a  nonrecourse  wrap-around  mortgage  loan of
approximately  $2,480,000.  On March 29, 1994,  the  Partnership  refinanced the
existing  wraparound  mortgage  note  secured by the  Northeast  Plaza  Shopping
Center,  which had been in default for over two years,  with a new  non-recourse
loan  issued by the prior  underlying  first  mortgage  lender (see Note 7). The
refinancing  was negotiated in conjunction  with a  restructuring  of the master
lease that covers the  Partnership's  interest in  Northeast  Plaza.  The master
lessee  was  also  the  holder  of  the  wraparound  mortgage.  As  part  of the
refinancing,  the wrap note  holder  applied  withheld  rental  payments,  which
totalled $661,000,  against the outstanding balance of the wraparound  mortgage.
Rental payments to the Partnership were reinstated beginning in April 1994.

      At  the  time  of  the  original  purchase  of the  shopping  center,  the
Partnership  entered into a lease  agreement with the seller of the property for
the operation and  management of the property.  The lease has an initial term of
30 years and two 5-year renewal  options.  This master lease  agreement has been
classified as an operating lease and, therefore,  rental income is reported when
earned. Under the terms of the agreement,  the Partnership receives annual basic
rent of $435,000.  The  Partnership  also receives  contingent rent equal to the
greater of (a)  approximately  47.5% of annual  increases to gross rental income
over a specified  base amount or (b) $43,000  annually.  The agreement  provides
specifically that the manager pay all costs of operating the shopping center and
all annual taxes, insurance and administrative  expenses. The manager is further
required to pay for all costs of repair and  replacement  required in connection
with the shopping  center.  Minimum lease payments under the initial term of the
lease agreement, including the minimum amount of contingent rent, will amount to
$478,000 in each year.

      Under the amended terms of the master lease,  upon the sale or refinancing
of the project,  any  remaining  proceeds,  after  repayment of the  outstanding
balance  on  the  mortgage  loan,  payment  of  certain  priority  items  to the
Partnership,   repayment  of  the  Partnership's  original  investment  and  the
reimbursement to the Lessee of certain capital improvement expenditures, will be
allocated  equally to the  Partnership  and to the manager of the  property as a
return on the leasehold interest.

5.  Joint Venture Partnerships
    --------------------------

      As of September 30, 1997,  the  Partnership  had  investments in one joint
venture (two as of September 30, 1996). As discussed further below, on August 1,
1997  the  Partnership  sold  its  joint  venture  interest  in the  Pine  Trail
Partnership to its  co-venture  partner.  In addition,  on June 19, 1996 Camelot
Associates,  in which the  Partnership  had a joint venture  interest,  sold its
operating  investment  property to an unrelated  third party and distributed the
net proceeds to the venture partners. The joint ventures are accounted for using
the equity method in the Partnership's financial statements.  Condensed combined
financial statements of these joint ventures follow.

                      Condensed Combined Balance Sheets
                         September 30, 1997 and 1996
                                (in thousands)

                                    Assets

                                                      1997             1996
                                                      ----             ----

   Current assets                                    $   793          $   935
   Operating investment property, net                  2,493           14,682
   Other assets, net                                     203              247
                                                     -------          -------
                                                     $ 3,489          $15,864
                                                     =======          =======

                      Liabilities and Capital (Deficit)

   Current liabilities                               $   469          $   803
   Other liabilities                                       9               23
   Long-term mortgage debt                             4,104           11,324
   Partnership's share of combined capital
      (deficit)                                           91            2,686
   Co-venturers' share of combined capital 
      (deficit)                                       (1,184)           1,028
                                                     -------          -------
                                                     $ 3,489          $15,864
                                                     =======          =======

                  Reconciliation of Partnership's Investment

                                                        1997            1996
                                                        ----            ----

   Partnership's share of capital, as shown above    $    91          $ 2,686
   Partnership's share of current
     liabilities and long-term debt                       91               64
   Excess basis due to investment in ventures,
     net (1)                                              33               94
                                                     -------          -------
   Investments in joint ventures, at equity          $   215          $ 2,844
                                                     =======          =======

   (1)At September 30, 1997 and 1996, the Partnership's  investment  exceeds its
      share of the joint venture  partnerships'  capital accounts by $33,000 and
      $94,000,  respectively.  This amount,  which  relates to certain  expenses
      incurred by the Partnership in connection with acquiring its joint venture
      investments,  is being  amortized  over the  estimated  useful life of the
      investment properties.

                    Condensed Combined Summary of Operations
              For the years ended September 30, 1997, 1996 and 1995
                                 (in thousands)

                                                1997        1996        1995
                                                ----        ----        ----
   Revenues:
     Rental revenues and expense recoveries   $ 3,232     $ 5,632     $ 6,186
     Interest income                               25          20          63
                                              -------     -------     -------
                                                3,257       5,652       6,249
   Expenses:
     Property operating expenses                1,121       2,473       2,729
     Depreciation and amortization                284         726         822
     Interest expense                           1,179       1,644       1,737
                                              -------     -------     -------
                                                2,584       4,843       5,288
   Operating income                               673         809         961

   Gain on sale of operating investment
     property                                       -      12,089           -
                                              -------     -------     -------

   Net income                                 $   673     $12,898     $   961
                                              =======     =======     =======

   Net income:
     Partnership's share of combined income   $   405     $ 8,134     $   610
     Co-venturers' share of combined income       268       4,764         351
                                              -------     -------     -------
                                              $   673     $12,898     $   961
                                              =======     =======     =======

               Reconciliation of Partnership's Share of Income

                                                 1997       1996         1995
                                                 ----       ----         ----

   Partnership's share of income, as 
     shown above                             $    405     $ 8,134     $   610
   Amortization of excess basis                    (2)     (1,512)       (100)
                                             --------     --------    -------
   Partnership's share of ventures' income   $    403     $ 6,622     $   510
                                             ========     =======     =======


      The Partnership's share of ventures' net income is presented as follows in
the statements of operations (in thousands):
                                                 1997       1996         1995
                                                 ----       ----         ----

        Partnership share of ventures'
          income                             $    403     $   696     $   510
        Partnership's share of gain on sale
          of operating investment property          -       5,926           -
                                             --------     -------     -------
                                             $    403     $ 6,622     $   510
                                             ========     =======     =======

      Investments  in  joint  ventures,  at  equity,  is the  Partnership's  net
investment in the joint venture  partnerships.  These joint ventures are subject
to partnership  agreements  which determine the distribution of available funds,
the  disposition  of the  ventures'  assets  and  the  rights  of the  partners,
regardless of the Partnership's  percentage  ownership  interest in the venture.
Substantially all of the  Partnership's  investments in these joint ventures are
restricted as to distributions.

<PAGE>


      Investments in joint  ventures,  at equity,  on the  accompanying  balance
sheets at  September  30,  1997 and 1996 is  comprised  of the  following  joint
venture investments:
                                                            1997       1996
                                                            ----       ----

        Boyer Lubbock Associates                          $   215     $    186
        Pine Trail Partnership                                  -        2,658
                                                          -------     --------
           Investments in joint ventures, at equity       $   215     $  2,844
                                                          =======     ========

      The Partnership received cash distributions from the joint ventures as set
forth below:

                                                 1997       1996        1995
                                                 ----       ----        ----

        Camelot Associates                    $     -      $6,078      $  274
        Boyer Lubbock Associates                  172         231         111
        Pine Trail Partnership                    275         400         360
                                              -------      ------      ------
           Total                              $   447      $6,709      $  745
                                              =======      ======      ======

      A description of the joint ventures' properties and the terms of the joint
venture agreements are summarized below.

a)  Pine Trail Partnership
    ----------------------

      On November 12, 1981, the  Partnership  acquired an interest in Pine Trail
Partnership,  a Florida  general  partnership  organized to own and operate Pine
Trail Center, a 266,042 square foot shopping center in West Palm Beach, Florida.
The  Partnership is a general  partner in the joint venture.  The  Partnership's
co-venturer is a partnership  comprised of certain individuals.  The Partnership
invested approximately $6,236,000 (including an acquisition fee of $645,600 paid
to the Adviser) for its 50% interest.  The co-venturer  contributed its interest
in the  property  to the joint  venture.  The joint  venture  is  subject  to an
institutional  nonrecourse  first mortgage which had a balance of  approximately
$8,140,000 at the time of the closing.

      On August 1, 1997,  the  Partnership  sold its  interest in the Pine Trail
Shopping  Center to its joint  venture  partner  for a net price of  $6,150,000.
Funds to complete this transaction were provided from a refinancing of the first
mortgage  debt  secured  by  the  Pine  Trail  property.  As a  result  of  this
transaction,  the Partnership made a special capital distribution to the Limited
Partners of $285.25 per original  $1,000  investment on September 15, 1997.  The
Partnership  no longer  holds an  interest  in this  property.  The  Partnership
recognized a gain of  $3,565,000  (net of the  write-off of  unamortized  excess
basis of $50,000) in connection  with this sale  transaction.  The amount of the
gain represents the difference  between the net proceeds received and the equity
method  carrying value of the  Partnership's  investment in the Pine Trail joint
venture as of the date of the sale.

      The joint venture agreement  provided that the Partnership would receive a
noncumulative annual cash distribution,  payable quarterly,  from net cash flow.
The first $515,000 of net cash flow was to be  distributed  to the  Partnership,
and the next $235,788 of net cash flow was to be distributed to the co-venturer.
Any excess cash flow was to be allocated  equally  between the Partners.  During
fiscal 1997,  1996 and 1995 the property did not generate  sufficient  cash flow
for the Partnership to receive its minimum preferred distribution of $515,000.

      Taxable income and tax loss from  operations in each year was allocated to
the Partnership and the co-venturer in the same proportions as cash distribution
entitlements,  subject to  adjustments in the case of tax loss for an allocation
of a minimum to the co-venturer. Allocations of the venture's operations between
the Partnership and the co-venturer for financial  accounting purposes have been
made in conformity with the allocations of taxable income or tax loss.

      The joint venture had entered into a property  management contract with an
affiliate of the co-venturer  cancellable at the option of the Partnership  upon
the  occurrence of certain  events.  The contract  provided for a management fee
equal to 4% of gross rents collected. For the ten months ended July 31, 1997 and
for the years ended  September 30, 1996 and 1995,  the property  manager  earned
fees of $63,000,  $74,000 and $76,000,  respectively.  In addition, the property
manager was entitled to leasing commissions at prevailing market rates.  Leasing
commissions earned by the property manager were $18,000, $23,000 and $41,000 for
the ten months  ended July 31, 1997 and for the years ended  September  30, 1996
and 1995, respectively.

<PAGE>

b)  Boyer Lubbock Associates
    ------------------------

      On June 30, 1981,  the  Partnership  acquired an interest in Boyer Lubbock
Associates,  a Texas  general  partnership  organized  to  purchase  and operate
Central  Plaza,  a 151,857 square foot shopping  center in Lubbock,  Texas.  The
Partnership  is a  general  partner  in the  joint  venture.  The  Partnership's
co-venturer  is an  affiliate  of The Boyer  Company.  Revenue  from three major
tenants of Central Plaza  accounted for 27%, 17% and 11% of the venture's  total
revenues for fiscal 1997.

      The aggregate cash  investment by the Partnership for its 50% interest was
approximately  $2,076,000  (including an acquisition fee of $225,000 paid to the
Adviser).  The  Partnership's  interest was acquired subject to an institutional
nonrecourse  first  mortgage with a balance of  approximately  $4,790,000 at the
time of  closing.  The  venture's  debt was  originally  scheduled  to mature on
December 1, 1994.  During the first quarter of fiscal 1995, the venture obtained
an extension of the maturity date from the lender to January 1, 1995. During the
second quarter of fiscal 1995,  the venture  obtained a mortgage loan from a new
lender which enabled the venture to repay,  in full,  this maturing  obligation.
The new loan, in the initial principal amount of $4,200,000, bears interest at a
rate  of  10%  per  annum.   Monthly  payments  of  principal  and  interest  of
approximately  $37,000 are due until  maturity in January  2002.  The loan had a
balance of $4,135,000 at September 30, 1997.

      The joint venture  agreement  between the  Partnership and the co-venturer
provides that from  available cash flow the  Partnership  will receive an annual
preference,  payable monthly, of $171,000,  and the co-venturer will receive the
remaining  distributable cash up to a maximum of $120,000.  Additional cash flow
will be distributed equally to the Partnership and the co-venturer.

      Taxable income and tax loss before depreciation are generally allocated in
accordance  with cash  distributions,  after equal  allocation of profits in the
amount  required to be transferred  to the capital cash reserve  accounts and to
amortize  the  indebtedness  of  the  joint  venture.  Depreciation  expense  is
allocated in accordance with the tax basis of the capital  contributions  of the
Partnership and the  co-venturer,  after  adjustment for liabilities and capital
improvements.  In the event of no available cash flow, 100% of remaining  profit
or loss is allocated to the Partnership. Allocations of the venture's operations
between the Partnership and the  co-venturer for financial  accounting  purposes
have been made in conformity with the allocations of taxable income or tax loss.

      Upon  sale  or  refinancing,   the  Partnership  will  receive  the  first
$2,000,000,  plus certain  closing costs,  as a first priority in  distributions
from available sale or refinancing proceeds after the repayment of the remaining
balance on the first  mortgage.  The next  $1,625,000 will be distributed to the
co-venturer.   Any  remaining  proceeds  will  be  distributed  equally  to  the
Partnership and the co-venturer.

      The  Central  Plaza   property  is  co-managed  by  an  affiliate  of  the
co-venturer  and an unrelated  third party.  For the years ended  September  30,
1997,  1996 and 1995, the affiliate of the  co-venturer  earned fees of $38,000,
$41,000 and $37,000,  respectively. In addition, during the year ended September
30, 1995 lease commissions aggregating $7,000 were also paid to the affiliate of
the  co-venturer.  No lease  commissions  were paid to affiliates  for the years
ended September 30, 1997 and 1996.


<PAGE>

c)  Camelot Associates
    ------------------

      On June  29,  1981,  the  Partnership  acquired  an  interest  in  Camelot
Associates  ("Camelot")  an Ohio  limited  partnership  which owned and operated
Camelot  Apartments,  a 492-unit  apartment  complex  in  Fairfield,  Ohio.  The
aggregate  cash   investment  by  the  Partnership  for  its  50%  interest  was
approximately  $2,790,000  (including an acquisition fee of $300,000 paid to the
Adviser).  The  Partnership  was a general  partner  in the joint  venture.  The
Partnership's   co-venturers   were  Chelsea  Moore   Corporation   and  certain
individuals.

      On June 19, 1996,  the joint  venture  which owned the Camelot  Apartments
sold  the  operating  investment  property  to  an  unrelated  third  party  for
$15,150,000.  The Partnership  received net sales proceeds of approximately $5.9
million after deducting  closing costs,  the repayment of the outstanding  first
mortgage loans, the buyout of an underlying  ground lease and the  co-venturers'
share of the net proceeds.  The Partnership  made a special  distribution to the
Limited Partners from the Camelot sale proceeds of  approximately  $5.5 million,
or $256 per original  $1,000  investment,  on August 15, 1996. The remaining net
proceeds  were added to the  Partnership's  cash  reserves  to  provide  for the
potential capital needs of the  Partnership's  remaining  investments.  The gain
recognized   by  the  Camelot  joint  venture   totaled   $12,089,000   and  the
Partnership's share of such gain amounted to $5,926,000, net of the write-off of
the unamortized  balance of the Partnership's  excess basis in the Camelot joint
venture of $1,506,000.

      Taxable income and tax loss from operations in each year were allocated to
the  Partnership  and  the  co-venturers   generally  in  accordance  with  cash
distributions  except that all  depreciation  attributable to a step-up in basis
pursuant to an election  under  Section 754 of the  Internal  Revenue  Code as a
result of the investment by the  Partnership  was allocated to the  Partnership.
Allocations  of  the  venture's   operations   among  the  Partnership  and  the
co-venturers for financial accounting purposes have been made in conformity with
the allocations of taxable income or tax loss.

      The joint venture had entered into a property  management contract with an
affiliate  of the  co-venturers.  Fees due  under  the  terms of the  management
contract  amounted to 4% of collected  rents.  For the period October 1, 1995 to
June 19, 1996 and the year ended  September  30, 1995,  the  management  company
earned fees of $76,000 and $103,000, respectively.

6.  Note and Interest Receivable, Net
    ---------------------------------

      On  September  15,  1981,  the  Partnership  acquired  a 35%  interest  in
Briarwood Joint Venture,  an existing  Pennsylvania  general  partnership  which
owned  a  686-unit  apartment  complex  in  Bucks  County,   Pennsylvania.   The
Partnership   originally  invested   approximately   $4,815,000   (including  an
acquisition  fee of  $500,000  paid  to  the  Adviser)  for  its  interest.  The
Partnership's  interest was acquired  subject to two  institutional  nonrecourse
first mortgages with balances totalling approximately  $8,925,000 at the time of
the closing.

      On December 20, 1984,  the joint  venture  partners  sold their  ownership
interests in the Briarwood Joint Venture for  $33,152,000.  After the payment of
mortgage obligations and closing costs, the Partnership's allocable share of the
proceeds  was  $10,935,000,  represented  by  cash  of  $7,490,000  and  a  note
receivable  of  $3,445,000.   For  financial  accounting  purposes,  a  gain  of
$7,255,000  resulted from the transaction of which  $3,810,000 was recognized at
the time of the sale and the  remainder  was  deferred  under the cost  recovery
method.  For income tax purposes,  a gain of $4,829,000 was recognized upon sale
and the remainder deferred  utilizing the installment  method. The difference in
the amount of gain recognized for financial  accounting and tax purposes results
from accounting  differences  related to the carrying value of the Partnership's
investment.

      The principal  amount of the note receivable of $3,445,000  bears interest
at 9% annually and is subordinated  to a first mortgage.  Interest and principal
payments  on the note are  payable  only to the extent of net cash flow from the
properties  sold,  as defined in the sale  documents.  Any interest not received
will accrue additional  interest of 9% per annum. The  Partnership's  policy has
been to defer  recognition of all interest  income on the note until  collected,
due to the uncertainty of its  collectibility.  To date, the Partnership has not
received any interest  payments.  Per the terms of the note  agreement,  accrued
interest  receivable  as of September  30, 1997 and 1996 would be  approximately
$6,925,000  and  $6,068,000,  respectively.  Since the  properties  continue  to
generate   operating   deficits  and  the   Partnership's   note  receivable  is
subordinated to other first mortgage debt,  there is significant  uncertainty as
to the collectibility of both the principal and accrued interest as of September
30, 1997. As a result, the portion of the remaining gain to be recognized, which
is  represented  by the note and  accrued  interest,  has  been  deferred  until
realized in cash.
<PAGE>

7.  Mortgage Note Payable
    ---------------------

      The mortgage note payable at September 30, 1997 and 1996 is secured by the
Partnership's  wholly-owned  Northeast Plaza Shopping Center. On March 29, 1994,
the  Partnership  refinanced  the existing  wraparound  mortgage note secured by
Northeast Plaza,  which had been in default for over two years,  with a new loan
issued by the prior  underlying  first  mortgage  lender.  The new loan,  in the
initial  principal  amount  of  $1,722,000,  has a term of five  years and bears
interest  at a fixed  rate  of 9% per  annum.  Monthly  principal  and  interest
payments of $22,000 are due through  maturity on March 29, 1999. The loan may be
prepaid at anytime without penalty. The fair value of this mortgage note payable
approximated its carrying value as of September 30, 1997 and 1996.

      Scheduled maturities of the mortgage note payable for each of the next two
fiscal years are as follows (in thousands):

                  1998             $   154
                  1999               1,124
                                   -------
                                   $ 1,278
                                   =======

8.  Legal Proceedings and Related Contingencies
    -------------------------------------------

      Management  believes that the  Partnership's  efforts to sell or refinance
the Northeast  Plaza  property  have been impeded by potential  buyer and lender
concerns of an environmental  nature with respect to the property.  During 1990,
it was  discovered  that certain  underground  storage  tanks of a Mobil service
station located  adjacent to the shopping center had leaked and contaminated the
ground  water  in  the  vicinity  of  the  station.  Since  the  time  that  the
contamination was discovered, Mobil Oil Corporation (Mobil) has investigated the
problem and is  progressing  with efforts to remediate the soil and ground water
contamination  under the supervision of the Florida  Department of Environmental
Protection, which has approved Mobil's remedial action plan. During fiscal 1990,
the  Partnership had obtained an  indemnification  agreement from Mobil in which
Mobil  agreed to bear the cost of all damages and  required  clean-up  expenses.
Furthermore,  Mobil  indemnified the Partnership  against its inability to sell,
transfer,  or obtain  financing  on the property  because of the  contamination.
Subsequent to the discovery of the  contamination,  the Partnership  experienced
difficulty  in  refinancing  the mortgages on the property that matured in 1991.
The  existence  of  contamination  on the property  impacted  the  Partnership's
ability to obtain standard  market  financing.  Ultimately,  the Partnership was
able to refinance its first mortgage at a  substantially  reduced  loan-to-value
ratio.  In  addition,  the  Partnership  was unable to sell the  property  at an
uncontaminated  market price.  The Partnership also retained outside counsel and
environmental consultants to review Mobil's remediation efforts and has incurred
significant  out-of-pocket  expenses in connection with this situation.  Despite
repeated  requests by the  Partnership for  compensation  under the terms of the
indemnification   agreement,  to  date  Mobil  has  refused  to  compensate  the
Partnership for any of its damages. During the first quarter of fiscal 1993, the
Partnership  filed suit  against  Mobil for  breach of  indemnity  and  property
damage.  On April 28, 1995,  Mobil was successful in obtaining a Partial Summary
Judgment which removed the case from the Federal Court system. Subsequently, the
Partnership  filed an action in the Florida State Court  system.  This action is
for substantially all of the same claims and utilizes the substantial  discovery
and  trial  preparation  work  already  completed  for  the  Federal  case.  The
Partnership is seeking  judgment against Mobil which would award the Partnership
compensatory damages, out-of-pocket costs, attorneys' fees and such other relief
as the court may deem proper.  On November 14, 1996, the state court granted the
Partnership's Motion for Partial Summary Judgment as to liability with regard to
the Partnership's claims for damages, due to trespass and nuisance. By obtaining
a summary judgment of liability and subsequently defeating Mobil's appeal of the
summary judgment, the Partnership has firmly established Mobil Oil Corporation's
liability for the trespass and nuisance caused by the  contamination.  The trial
on these counts will focus directly on the damages  suffered by the Partnership.
In  addition,  the trial  court  found a  reasonable  evidentiary  basis for the
Partnership  to amend its complaint to seek punitive  damages  against Mobil for
certain  intentional or grossly negligent conduct which caused the contamination
of the  Center.  The  jury  will  determine  the  Partnership's  entitlement  to
compensatory and/or punitive damages,  if any. Finally,  the trial court granted
the  Partnership  leave to seek an  injunction  against  Mobil to force  them to
complete the cleanup of the Center on an expedited  basis. If the Partnership is
successful at trial,  the  injunction  will likely advance the completion of the
cleanup by several  years.  During  November  1996,  the  Partnership  and Mobil
attempted to settle the action through mediation. A settlement was not achieved.
Mobil's proposal to settle the case,  which included a proposed  purchase of the
contaminated  portion of the  Northeast  Plaza  property  from the  Partnership,
failed due to Mobil's  inability to obtain a zoning variance which was necessary
to make such a transaction  possible.  The matter is set for a jury trial during
the two-week period  commencing  April 6, 1998. The completion of discovery will
occur  during the second  quarter of fiscal  1998.  The  Partnership  is seeking
damages in excess of $2,000,000.  Subject to the foregoing,  it is impossible to
determine at this time, with reasonable certainty, the likely range of potential
recovery, if any, by the Partnership.
<PAGE>

9.  Subsequent Event
    ----------------

      On November 15, 1997, the Partnership  distributed $105,000 to the Limited
Partners and $1,000 to the General  Partner for the quarter ended  September 30,
1997.

<PAGE>

Schedule III - Real Estate and Accumulated Depreciation

PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
              Schedule of Real Estate and Accumulated Depreciation

                               September 30, 1997
                                 (In thousands)
<TABLE>
<CAPTION>

                                                                                                                      Life on Which 
                        Initial Cost to      Costs         Gross Amount at Which Carried at                           Depreciation
                         Partnership         Capitalized             Close of period                                  in Latest 
                          Buildings          (Removed)         Buildings                                              Income  
                               and           Subsequent to     and                Accumulated  Date of       Date     Statement
Description Encumbrances Land  Improvements  Acquisition  Land Improvements Total Depreciation Construction  Acquired is Computed
----------- ------------ ----  ------------  -----------  ----------------- ----- ------------ ------------  -------- -----------
<S>         <C>          <C>     <C>         <C>          <C>    <C>        <C>     <C>        <C>           <C>      <C>  

Shopping Center
Sarasota, 
 Florida    $ 1,278      $950    $1,930      $2,158       $950   $4,088     $5,038  $1,491     1964 - 1978   9/25/81   40 years
            =======      ====    ======      ======       ====   ======     ======  ======


Notes:

(A) The  aggregate  cost of real estate owned at September  30, 1997 for Federal income tax purposes is approximately $5,038,000.
(B) See Notes 4 and 7 to Financial Statements. 
(C) Reconciliation of real estate owned:

                                                   1997         1996          1995
                                                   ----         ----          ----

Balance at beginning of year                     $ 5,038       $ 5,038       $ 5,038
Improvements                                                         -             -                -
                                                 -------       -------       -------
Balance at end of year                           $ 5,038       $ 5,038       $ 5,038
                                                 =======       =======       =======

(D) Reconciliation of accumulated depreciation:

Balance at beginning of year                     $ 1,389       $ 1,287       $ 1,185
Depreciation expense                                 102           102           102
                                                 -------       -------       -------
Balance at end of year                           $ 1,491       $ 1,389       $ 1,287
                                                 =======       =======       =======

</TABLE>

<PAGE>





                         REPORT OF INDEPENDENT AUDITORS


The Partners of
Paine Webber Income Properties Three Limited Partnership:

      We have audited the  accompanying  combined balance sheets of the Combined
Joint Ventures of Paine Webber Income Properties Three Limited Partnership as of
September 30, 1997 and 1996, and the related  combined  statements of income and
changes in venturers' capital, and cash flows for each of the three years in the
period  ended  September  30,  1997.  Our audits  also  included  the  financial
statement schedule listed in the Index at Item 14(a). These financial statements
and  schedule  are  the  responsibility  of the  Partnership's  management.  Our
responsibility  is to  express  an opinion  on these  financial  statements  and
schedule  based on our  audits.  We did not audit the  financial  statements  of
Camelot  Associates,  which statements  reflect total revenues of $2,044,000 and
$2,729,000 for the years ended September 30, 1996 and 1995, respectively.  Those
statements  were audited by other  auditors,  whose report has been furnished to
us,  and our  opinion,  insofar  as it  relates  to data  included  for  Camelot
Associates, is based solely on the report of the other auditors.

      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 and the report of other auditors provide a reasonable
basis for our opinion.

      In our opinion,  based on our audits and the report of other auditors, the
combined financial  statements referred to above present fairly, in all material
respects,  the combined  financial  position of the Combined  Joint  Ventures of
Paine Webber Income  Properties Three Limited  Partnership at September 30, 1997
and 1996, and the combined  results of their operations and their cash flows for
each of the three years in the period  ended  September  30, 1997 in  conformity
with generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements  taken as a whole,  presents  fairly  in all  material  respects  the
information set forth therein.





                                /s/ Ernst & Young LLP
                                ---------------------
                                ERNST & YOUNG LLP






Boston, Massachusetts
November 21, 1997


<PAGE>


                        Report of Independent Accountants



To the Venturers of
Camelot Associates:

      We have audited the accompanying  balance sheets of Camelot Associates (an
Ohio  Partnership)  as of June 19, 1996 and September 30, 1995,  and the related
statements of income,  venturers'  deficit and cash flows for the period October
1,  1995 to June  19,  1996 and for each of the two  years in the  period  ended
September 30, 1995.  These financial  statements are the  responsibility  of the
Partnership's  management.  Our responsibility is to express an opinion on these
financial statements 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 Camelot Associates (an Ohio
Partnership)  as of June 19, 1996 and September 30, 1995, and the results of its
operations  and its cash flows for the period  October 1, 1995 to June 19,  1996
and for  each of the two  years in the  period  ended  September  30,  1995,  in
conformity with generally accepted accounting principles.

      As described in Note 1, the partnership  sold its operating  properties in
1996.




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






Cincinnati, Ohio
January 10, 1997


<PAGE>


                           COMBINED JOINT VENTURES OF
            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                             COMBINED BALANCE SHEETS
                           September 30, 1997 and 1996
                                 (In thousands)

                                     Assets
                                                        1997            1996
                                                        ----            ----
Current assets:
   Cash and cash equivalents                         $   378          $   198
   Escrowed funds, principally for payment of 
     real estate taxes                                   307              490
   Accounts receivable                                    67              129
   Note receivable                                        40               80
   Prepaid expenses                                        1               36
   Capital improvement reserve                             -                2
                                                     -------          -------
      Total current assets                               793              935

Operating investment properties:
   Land                                                  967            3,893
   Buildings, improvements and equipment               5,587           20,411
                                                     -------          -------
                                                       6,554           24,304
   Less accumulated depreciation                      (4,061)          (9,622)
                                                     -------          -------
          Net operating investment properties          2,493           14,682

Deferred expenses, net of accumulated amortization
  of $243 ($201 in 1996)                                 203              247
                                                     -------          -------
                                                     $ 3,489          $15,864
                                                     =======          =======

                  Liabilities and Venturers' Capital (Deficit)
Current liabilities:
   Accounts payable                                 $     23          $    64
   Distributions payable to venturers                    275               50
   Accrued interest                                       34              125
   Accrued real estate taxes                             106              333
   Other accrued liabilities                               -               26
   Long-term debt - current portion                       31              205
                                                     -------          -------
      Total current liabilities                          469              803

Notes payable                                              -               14

Tenant security deposits                                   9                9

Long-term debt                                         4,104           11,324

Venturers' capital (deficit)                          (1,093)           3,714
                                                     -------          -------
                                                     $ 3,489          $15,864
                                                     =======          =======



                             See accompanying notes.


<PAGE>


                           COMBINED JOINT VENTURES OF
            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

    COMBINED STATEMENTS OF INCOME AND CHANGES IN VENTURERS' CAPITAL (DEFICIT)
              For the years ended September 30, 1997, 1996 and 1995
                                 (In thousands)


                                                 1997       1996        1995
                                                 ----       ----        ----
Revenues:
   Rental income                              $ 2,515     $ 4,892     $ 5,479
   Reimbursements from tenants                    717         740         707
   Interest and other income                       25          20          63
                                              -------     -------     -------
                                                3,257       5,652       6,249

Expenses:
   Interest expense                             1,179       1,644       1,737
   Depreciation expense                           266         710         806
   Real estate taxes                              408         553         632
   Management fees                                101         190         215
   Ground rent                                     96         126         147
   Repairs and maintenance                        372         623         674
   Insurance                                       28          73          89
   Utilities                                       59         229         257
   General and administrative                      57         360         266
   Other                                            -         319         449
   Amortization expense                            18          16          16
                                              -------     -------     -------
                                                2,584       4,843       5,288
                                              -------     -------     -------

Operating income                                  673         809         961

Gain on sale of operating investment
  property                                          -      12,089           -
                                              -------     -------     -------

Net income                                        673      12,898         961

Distributions to venturers                       (621)    (10,939)     (1,177)

Reduction in combined capital due to
  sale of joint venture interest (Note 3)      (4,859)          -           -

Venturers' capital, beginning of year           3,714       1,755       1,971
                                              -------     -------     -------

Venturers' capital (deficit), end of year     $(1,093)    $ 3,714     $ 1,755
                                              =======     =======     =======











                             See accompanying notes.


<PAGE>


                           COMBINED JOINT VENTURES OF
            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                        COMBINED STATEMENTS OF CASH FLOWS
             For the years ended September 30, 1997, 1996 and 1995
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)

                                                1997        1996        1995
                                                ----        ----        ----
Cash flows from operating activities:
   Net income                                 $   673   $  12,898    $    961
   Adjustments to reconcile net income to
     net cash provided by operating activities:
      Depreciation and amortization               284         726         822
      Amortization of deferred financing costs     26          26          29
      Gain on sale of operating investment
        property                                    -     (12,089)          -
      Changes in assets and liabilities:
         Escrowed funds                           (34)        (39)       (119)
         Accounts receivable                      (50)        (38)         49
         Note receivable                           40         (80)          -
         Prepaid expenses                          23          (1)         (1)
         Capital improvement reserve                -          (2)         10
         Deferred expenses                        (29)        (59)       (198)
         Accounts payable                         (35)       (114)         95
         Accrued interest                           1         (33)          3
         Accrued real estate taxes                (45)       (125)         34
         Other accrued liabilities                 (3)         (2)         (4)
         Prepaid rent                               -         (18)         (1)
         Tenant security deposits                   -         (88)         (3)
                                              -------   ---------     -------
            Total adjustments                     178     (11,936)        716
                                              -------   ---------     -------
            Net cash provided by 
              operating activities                851         962       1,677
                                              -------   ---------     -------

Cash flows from investing activities:
   Additions to operating investment
     properties                                   (64)       (230)       (544)
   Proceeds from sale of operating investment
     property                                       -      14,470           -
                                              -------   ---------     -------
            Net cash (used in) provided by
                investing activities              (64)     14,240        (544)
                                              -------   ---------     -------

Cash flows from financing activities:
   Principal payments on long-term debt          (173)     (4,479)     (4,321)
   Distributions to venturers                    (432)    (11,325)     (1,011)
   Proceeds from refinancing of debt                -           -       4,200
   Proceeds of long-term debt                       -           -         350
                                              -------   ---------     -------
            Net cash used in financing
                activities                       (605)    (15,804)      (782)
                                              -------   ---------     -------

Net increase (decrease) in cash and 
  cash equivalents                                182       (602)        351

Less:  cash balance of Pine Trail joint
       venture                                    (2)          -           -
                                             -------   ---------     -------
                                                 180        (602)       (351)

Cash and cash equivalents, beginning of year     198         800         449
                                             -------   ---------     -------

Cash and cash equivalents, end of year       $   378   $     198      $  800
                                             =======   =========      ======

Cash paid during the year for interest       $ 1,152   $   1,652      $1,734
                                             =======   =========      =======
                             See accompanying notes.


<PAGE>


                           COMBINED JOINT VENTURES OF
            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
                     NOTES TO COMBINED FINANCIAL STATEMENTS


1.  Organization and Nature of Operations
    -------------------------------------

      The  accompanying  financial  statements of the Combined Joint Ventures of
Paine  Webber  Income  Properties  Three  Limited  Partnership  (Combined  Joint
Ventures)  include the accounts of Camelot  Associates  (through the date of the
sale described below), an Ohio limited partnership;  Boyer Lubbock Associates, a
Utah limited  partnership  and Pine Trail  Partnership  (through the date of the
sale described below), a Florida general  partnership.  The financial statements
of the Combined  Joint  Ventures are  presented  in combined  form,  rather than
individually, due to the nature of the relationship between the co-venturers and
Paine Webber Income Properties Three Limited Partnership (PWIP3),  which owns or
owned a substantial  financial interest but does not have voting control in each
joint venture.

      The dates of PWIP3's acquisition of interests in the joint ventures are as
follows:

                                        Date of Acquisition
               Joint Venture                of Interest
            -----------------------     -------------------

            Camelot Associates                6/29/81
            Boyer Lubbock Associates          6/30/81
            Pine Trail Partnership           11/12/81

      During fiscal 1997, PWIP3 sold its interest in the Pine Trail  Partnership
to its  co-venturer  partner.  During fiscal 1996,  Camelot  Associates sold its
operating  investment  property and  distributed the net proceeds to the venture
partners. See Note 3 for a further discussion of these transactions.

2.  Use of Estimates and Summary of Significant Accounting Policies
    ---------------------------------------------------------------

      The  accompanying  financial  statements have been prepared on the accrual
basis of accounting in accordance with generally accepted accounting  principles
which require  management  to make  estimates  and  assumptions  that affect the
reported amounts of assets and liabilities and disclosures of contingent  assets
and  liabilities as of September 30, 1997 and 1996 and revenues and expenses for
each of the three years in the period ended  September 30, 1997.  Actual results
could differ from the estimates and assumptions used.

      Basis of presentation
      ---------------------

      Generally,  the records of the combined  joint  ventures are maintained on
the income tax basis of accounting and adjusted to generally accepted accounting
principles for financial reporting purposes, principally for depreciation.

      Operating investment properties
      -------------------------------

      The operating investment  properties are recorded at cost less accumulated
depreciation or an amount less than cost if indicators of impairment are present
in accordance with Statement of Financial  Accounting  Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," which was adopted in fiscal 1997. SFAS 121 requires  impairment
losses to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets carrying amount.  Management  generally
assesses  indicators if impairment by a review of independent  appraisal reports
on the operating investment property.  Such appraisals make use of a combination
of  certain   generally   accepted   valuation   techniques,   including  direct
capitalization,  discounted cash flows and comparable  sales analysis.  SFAS 121
also  addresses the  accounting  for  long-lived  assets that are expected to be
disposed of. Acquisition fees have been capitalized and are included in the cost
of the  operating  investment  property.  Depreciation  expense is computed on a
straight-line   basis  over  the  estimated   useful  lives  of  the  buildings,
improvements and equipment, generally five to forty years.

      Deferred expenses
      -----------------

      Deferred expenses consist  primarily of loan fees and leasing  commissions
which are being amortized over the lives of the related loans and related leases
on  the  straight-line  method.   Amortization  of  deferred  loan  fees,  which
approximates  the effective  interest method is included in interest  expense on
the accompanying income statements.
<PAGE>

      Income tax matters
      ------------------

      The  Combined  Joint  Ventures  are  comprised  of entities  which are not
taxable and accordingly, the results of their operations are included on the tax
returns  of the  various  partners.  Accordingly  no  income  tax  provision  is
reflected in the accompanying combined financial statements.

      Fair Value of Financial Instruments
      -----------------------------------

      The  carrying  amounts of cash and cash  equivalents,  escrowed  funds and
reserved  cash  approximate  their fair values as of September 30, 1997 and 1996
due to the short-term maturities of these instruments. Information regarding the
fair value of long-term  debt is provided in Note 5. The fair value of long-term
debt is estimated  using  discounted  cash flow  analyses,  based on the current
market rate for similar types of borrowing arrangements.

      Cash and cash equivalents
      -------------------------

      For  purposes of the  statement of cash flows,  cash and cash  equivalents
include all highly liquid investments with maturities of 90 days or less.

      Capital improvement reserve
      ---------------------------

      In  accordance   with  the  joint  venture   agreement  of  Boyer  Lubbock
Associates, a capital improvement reserve account was established to insure that
adequate  funds are  available  to pay for future  capital  improvements  to the
venture's  operating  investment  property.  At the end of each month, 1% of the
gross minimum base rents and percentage  rents collected from tenants during the
month is to be deposited into this account. These deposits have not been made on
a  monthly  basis but have been  made  periodically  throughout  the year in the
aggregate required amounts.

3.  Joint Ventures
    --------------

      See Note 5 to the financial  statements  of PWIP3  included in this Annual
Report for a more detailed  description of the joint  ventures.  Descriptions of
the ventures' properties are summarized below:

      a.  Camelot Associates
          ------------------

      The  joint  venture  owned and  operated  Camelot  East and the  Villas of
Camelot Apartments, a 492-unit apartment complex, located in Fairfield, Ohio. On
June 19, 1996,  the joint venture sold the operating  investment  property to an
unrelated  third party for  $15,150,000.  PWIP3  received net sales  proceeds of
approximately  $5.9 million after deducting  closing costs, the repayment of the
two outstanding  first mortgage loans, the buyout of an underlying  ground lease
and the co-venturers' share of the net proceeds.

      b.  Boyer Lubbock Associates
          ------------------------

      The joint  venture owns and operates  Central  Plaza  Shopping  Center,  a
151,857 square foot shopping center, located in Lubbock, Texas.

      c.  Pine Trail Partnership
          ----------------------

      The joint venture owned and operated Pine Trail Shopping Center, a 266,042
square foot shopping center,  located in West Palm Beach,  Florida. On August 1,
1997,  PWIP 3 sold its interest in the Pine Trail  Shopping  Center to its joint
venture  partner  for  a  net  price  of  $6,150,000.  Funds  to  complete  this
transaction  were provided from a refinancing of the first mortgage debt secured
by the Pine Trail property. PWIP 3 no longer holds an interest in this property.
As a result,  the accounts of Pine Trail  Partnership  are no longer included in
these combined financial statements effective as of August 1, 1997. Pine Trails'
net  capital  of  $4,859,000  as of July 31,  1997 is shown  as a  reduction  of
combined capital on the accompanying  statement of changes in venturers' capital
(deficit).

      The following description of the joint venture agreements provides certain
general information.
<PAGE>

      Allocations of net income and loss
      ----------------------------------

      The joint venture agreements generally provide that taxable income and tax
loss from  operations are allocated  between PWIP3 and the  co-venturers  in the
same  proportion  as net cash flow  distributed  to each  partner for such year,
except for certain items which are  specifically  allocated to the partners,  as
defined  in the joint  venture  agreements.  Allocations  of income and loss for
financial  reporting  purposes have been made in accordance with the allocations
of taxable income and loss.

      Gains or losses resulting from sales or other dispositions of the projects
shall be allocated as specified in the joint venture agreements.

      Distributions
      -------------

      The joint venture agreements  generally provide that distributions will be
paid  first to PWIP3  from net cash flow  monthly or  quarterly,  equivalent  to
$171,000 annually in the case of Boyer Lubbock  Associates and $515,000 annually
for  Pine  Trail   Partnership.   After  payment  of  certain   amounts  to  the
co-venturers,  any  remaining  net  cash  flow is to be  allocated  between  the
partners in accordance with their respective ownership percentages.

      Distribution of net proceeds resulting from the sale or refinancing of the
properties  shall be made in  accordance  with  formulas  provided  in the joint
venture agreements.

4.  Related party transactions
    --------------------------

      The  Combined  Joint  Ventures  have  entered  into  property   management
agreements  with  affiliates  of the  co-venturers,  cancellable  at  the  joint
ventures'  option upon the occurrence of certain  events.  The  management  fees
generally  are equal to 4% of gross  receipts,  as  defined  in the  agreements.
Management  fees  totalling  $101,000,   $190,000  and  $215,000  were  paid  to
affiliates of the  co-venturers for the years ended September 30, 1997, 1996 and
1995, respectively.

      Certain of the joint ventures pay leasing commissions to affiliates of the
co-venturers.  Leasing  commissions  paid to  affiliates  amounted  to  $18,000,
$23,000 and $48,000 in fiscal 1997, 1996 and 1995, respectively.

5.  Long-term debt
    --------------

      Long-term  debt at September  30, 1997 and 1996  consists of the following
(in thousands):

                                                            1997        1996
                                                            ----        ----

     10%   nonrecourse   mortgage   loan
secured   by  Central   Plaza   Shopping
Center,  payable in monthly installments
of $37, including interest, with a final
payment of $3,983  due  January 2, 2002.
The  fair  value of this  mortgage  note
payable  approximated its carrying value
as of  September  30,  1997 and 1996.                       $ 4,135   $ 4,162

     12.25%  mortgage note,  payable $85
per  month  including  interest  with  a
payment of $5,874  due  January 1, 2001,
secured  by  the  Pine  Trail   Shopping
Center.  The fair value of this mortgage
note payable  approximated  $7,476 as of
September  30,  1996.   See   discussion
below.                                                            -     7,023

     Mortgage  note bearing  interest at
prime  plus 1% (9.25% at  September  30,
1996),  payable $3 per month,  including
interest,  with a payment of $329 due in
2000,  secured  by 1.4 acres of land and
the operating  investment  thereon owned
by the Pine  Trail  joint  venture.  The
fair value of this mortgage note payable
approximated  its  carrying  value as of
September 30, 1996.                                               -       344
                                                            -------   -------
                                                              4,135    11,529
      Less amounts due within one year                          (31)     (205)
                                                            -------   -------
                                                            $ 4,104   $ 11,324
                                                            =======   ========

      Scheduled maturities of long-term debt for each of the next five years are
as follows (in thousands):

                             1998                  $     31
                             1999                        33
                             2000                        37
                             2001                        41
                             2002                     3,993
                                                   --------
                                                   $  4,135
                                                   ========

      The 12.25%  mortgage  loan secured by the Pine Trail  Shopping  Center was
refinanced  on August 1, 1997.  The proceeds  from the new mortgage loan allowed
the joint venture  partner to payoff the previous  mortgage loan and to purchase
PWIP3's joint venture interest for $6,150,000.

6.  Leases
    ------

      The  Combined  Joint  Ventures  derive a portion  of their  revenues  from
noncancellable  shopping  center  operating  leases.  The initial  terms of such
leases  range from five to  twenty-five  years with the  majority  of the leases
containing  renewal  options.  Revenue from three major  tenants of the property
owned  by  Boyer  Lubbock  Associates  accounted  for  27%,  17%  and 11% of the
venture's total revenues for the year ended September 30, 1997.

      Minimum  future  rentals due to be  received  on  existing  noncancellable
operating  leases by Boyer Lubbock  Associates for the years ending September 30
and thereafter are as follows (in thousands):

                             1998        $      915
                             1999               831
                             2000               732
                             2001               565
                             2002               529
                             Thereafter       3,530
                                         ----------
                               Total     $    7,102
                                         ==========

     The above amounts do not include contingent rentals based on cost of living
increases and rentals which may be received under certain leases on the basis of
a percentage of sales in excess of stipulated minimums.



<PAGE>


Schedule III - Real Estate and Accumulated Depreciation
                           COMBINED JOINT VENTURES OF
            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
              Schedule of Real Estate and Accumulated Depreciation

                               September 30, 1997
                                 (In thousands)
<TABLE>
<CAPTION>

                                                                                                                      Life on Which 
                        Initial Cost to      Costs         Gross Amount at Which Carried at                           Depreciation
                         Partnership         Capitalized             Close of period                                  in Latest 
                          Buildings          (Removed)         Buildings                                              Income  
                               and           Subsequent to     and                Accumulated  Date of       Date     Statement
Description Encumbrances Land  Improvements  Acquisition  Land Improvements Total Depreciation Construction  Acquired is Computed
----------- ------------ ----  ------------  -----------  ---- ------------ ----- ------------ ------------  -------- -----------
<S>         <C>          <C>     <C>         <C>          <C>    <C>        <C>       <C>      <C>           <C>      <C>  

Shopping 
 Center     $ 4,135     $ 967   $4,573      $1,014       $  967  $ 5,587   $ 6,554   $4,061   1978-80       6/30/81  15-31.5 yrs.
Lubbock, TX

Notes:
(A) The  aggregate  cost of real estate owned at September  30, 1997 for Federal income tax  purposes  is  approximately $6,554,000.
(B) See Note 5 to Combined Financial  Statements for a description of the terms of the debt encumbering the properties.
(C) Reconciliation of real estate owned:
                                                   1997          1996          1995
                                                   ----          ----          ----

Balance at beginning of year                     $24,304       $31,792       $31,248
Increase due to additions                             64           230           544
Reduction due to sale of joint
  venture interest                               (17,814)            -             -
Write-off due to dispositions                          -        (7,718)            -
                                                 -------       -------       -------
Balance at end of year                           $ 6,554       $24,304       $31,792
                                                 =======       =======       =======

(D) Reconciliation of accumulated depreciation:

Balance at beginning of year                    $  9,622       $14,282       $13,476
Depreciation expense                                 266           710           806
Reduction due to sale of joint venture interest   (5,827)            -             -
Decreases due to dispositions                          -        (5,370)            -
                                                --------      --------       -------
Balance at end of year                          $  4,061       $ 9,622       $14,282
                                                ========       =======       =======
</TABLE>