<PAGE>
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
 
                                   FORM 10-Q
 
(Mark One)
 
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
 
For the quarterly period ended June 30, 1997
 
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
 
For the transition period from _______________________ to ______________________
 
Commission file number: 0-14397
 
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
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             (Exact name of registrant as specified in its charter)
 
Texas                                           75-1991528
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(State or other jurisdiction            (I.R.S. Employer Identification No.)
of incorporation or organization)
 
One Seaport Plaza, New York, NY                 10292-0128
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(Address of principal executive offices)        (Zip Code)
 
Registrant's telephone number, including area code (212) 214-1016
 
                                      N/A
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   Former name, former address and former fiscal year, if changed since last
                                    report.
 
   Indicate by check CK 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 _CK_  No __

<PAGE>
                         Part I. FINANCIAL INFORMATION
                          ITEM 1. FINANCIAL STATEMENTS
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                            STATEMENT OF NET ASSETS
                          (in process of liquidation)
                                  (Unaudited)
 
<TABLE>
<CAPTION>
                                                                                       June 30,
                                                                                         1997
<S>                                                                                  <C>
--------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents                                                             $ 1,136,614
Property held for sale                                                                    275,000
                                                                                     -------------
Total assets                                                                            1,411,614
                                                                                     -------------
LIABILITIES
Estimated liquidation costs                                                               229,136
                                                                                     -------------
Contingencies
Net assets available to limited and general partners                                  $ 1,182,478
                                                                                     -------------
                                                                                     -------------
Limited and equivalent partnership units issued and outstanding                            53,855
                                                                                     -------------
                                                                                     -------------
--------------------------------------------------------------------------------------------------
</TABLE>
 
                        STATEMENT OF FINANCIAL CONDITION
                             (going concern basis)
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                                     September 30,
                                                                                         1996
<S>                                                                                  <C>
--------------------------------------------------------------------------------------------------
ASSETS
Property held for sale                                                                $10,772,457
Cash and cash equivalents                                                               1,139,947
Other assets                                                                                9,250
                                                                                     -------------
Total assets                                                                          $11,921,654
                                                                                     -------------
                                                                                     -------------
LIABILITIES AND PARTNERS' CAPITAL
Liabilities
Note payable                                                                          $   638,000
Accounts payable and accrued expenses                                                     314,401
Accrued real estate taxes                                                                 135,671
Deposits due to tenants                                                                   104,957
Due to affiliates                                                                          59,144
Unearned rental income                                                                     24,255
                                                                                     -------------
Total liabilities                                                                       1,276,428
                                                                                     -------------
Partners' capital
Limited partners (53,855 limited and equivalent units issued and outstanding)          10,428,257
General partners                                                                          216,969
                                                                                     -------------
Total partners' capital                                                                10,645,226
                                                                                     -------------
Total liabilities and partners' capital                                               $11,921,654
                                                                                     -------------
                                                                                     -------------
--------------------------------------------------------------------------------------------------
                 The accompanying notes are an integral part of these statements
</TABLE>
                                       2
<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                       STATEMENT OF CHANGES IN NET ASSETS
                          (in process of liquidation)
                                  (Unaudited)
 
<TABLE>
<CAPTION>
                                                             LIMITED       GENERAL
                                                            PARTNERS       PARTNERS        TOTAL
<S>                                                        <C>             <C>          <C>
---------------------------------------------------------------------------------------------------
Net assets in liquidation, October 1, 1996                 $10,428,257     $216,969     $10,645,226
Gain on sale of properties                                     327,104        3,304         330,408
Net loss from liquidating activities                          (186,424)      (1,883)       (188,307)
Distributions                                               (9,645,300)       --         (9,645,300)
                                                           -----------     --------     -----------
Net assets in liquidation, December 31, 1996                   923,637      218,390       1,142,027
Changes in estimated liquidation values of assets and
  liabilities                                                  258,841     (218,390)         40,451
                                                           -----------     --------     -----------
Net assets in liquidation, June 30, 1997                   $ 1,182,478     $     --     $ 1,182,478
                                                           -----------     --------     -----------
                                                           -----------     --------     -----------
---------------------------------------------------------------------------------------------------
</TABLE>
 
                            STATEMENTS OF OPERATIONS
                             (going concern basis)
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                        Nine Months     Three Months
                                                                           Ended           Ended
                                                                         June 30,         June 30,
                                                                           1996             1996
<S>                                                                     <C>             <C>
----------------------------------------------------------------------------------------------------
REVENUES
Rental income                                                           $1,510,354        $501,945
Interest                                                                    20,797           7,935
Other                                                                       11,326           3,779
                                                                        -----------     ------------
                                                                         1,542,477         513,659
                                                                        -----------     ------------
EXPENSES
Property operating                                                         541,624         172,435
General and administrative                                                 479,311         249,945
Real estate taxes                                                          184,457          51,260
Depreciation                                                               136,271              --
Interest                                                                    20,624          (2,877)
                                                                        -----------     ------------
                                                                         1,362,287         470,763
                                                                        -----------     ------------
Net income                                                              $  180,190        $ 42,896
                                                                        -----------     ------------
                                                                        -----------     ------------
ALLOCATION OF NET INCOME
Limited partners                                                        $  156,236        $ 39,464
                                                                        -----------     ------------
                                                                        -----------     ------------
General partners                                                        $   23,954        $  3,432
                                                                        -----------     ------------
                                                                        -----------     ------------
Net income per limited partnership unit                                 $     2.92        $    .74
                                                                        -----------     ------------
                                                                        -----------     ------------
----------------------------------------------------------------------------------------------------
                  The accompanying notes are an integral part of these statements
</TABLE>
                                       3
<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                            STATEMENT OF CASH FLOWS
                             (going concern basis)
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                                      Nine Months
                                                                                         Ended
                                                                                       June 30,
                                                                                         1996
<S>                                                                                   <C>
-------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Rental income and deposits received                                                   $ 1,474,128
Interest received                                                                          20,797
Other income received                                                                      11,326
Property operating expenses paid                                                         (525,474)
Real estate taxes paid                                                                   (151,006)
General and administrative expenses paid                                                 (294,778)
Interest paid                                                                             (39,612)
                                                                                      -----------
Net cash provided by operating activities                                                 495,381
                                                                                      -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net proceeds from sale of land                                                          1,000,000
Property improvements                                                                    (137,467)
                                                                                      -----------
Net cash provided by (used in) investing activities                                       862,533
CASH FLOWS FROM FINANCING ACTIVITIES
Distributions paid to partners                                                         (1,218,313)
                                                                                      -----------
Net increase (decrease) in cash and cash equivalents                                      139,601
Cash and cash equivalents at beginning of period                                        1,008,091
                                                                                      -----------
Cash and cash equivalents at end of period                                            $ 1,147,692
                                                                                      -----------
                                                                                      -----------
-------------------------------------------------------------------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Net income                                                                            $   180,190
                                                                                      -----------
Adjustments to reconcile net income to net cash provided by
  operating activities:
Depreciation                                                                              136,271
Changes in:
Other assets                                                                              (34,465)
Accounts payable and accrued expenses                                                     160,602
Accrued real estate taxes                                                                  33,451
Due to affiliates                                                                          21,092
Deposits due to tenants                                                                     7,319
Unearned rental income                                                                     (9,079)
                                                                                      -----------
Total adjustments                                                                         315,191
                                                                                      -----------
Net cash provided by operating activities                                             $   495,381
                                                                                      -----------
                                                                                      -----------
-------------------------------------------------------------------------------------------------
                  The accompanying notes are an integral part of this statement
</TABLE>
                                       4
<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                         NOTES TO FINANCIAL STATEMENTS
                                 JUNE 30, 1997
                                  (Unaudited)
 
A. General
 
   These financial statements have been prepared without audit. In the opinion
of Prudential-Bache Properties, Inc. ('Managing General Partner') ('PBP'), the
financial statements for the period ended June 30, 1997 contain all adjustments
necessary to present fairly such information subject to the effects of any
further liquidation accounting adjustments that would have been required had the
current realizable values of assets and the amounts of liabilities been known
when Prudential-Bache/Watson & Taylor, Ltd.-3 (the 'Partnership') first adopted
the liquidation basis of accounting as of October 1, 1996. Prior to October 1,
1996, the books and records of the Partnership were maintained on a going
concern accrual basis of accounting.
   Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting
principles have been omitted. It is suggested that these financial statements be
read in conjunction with the financial statements and notes thereto included in
the Partnership's Annual Report on Form 10-K filed with the Securities and
Exchange Commission for the year ended September 30, 1996.
   Net assets at June 30, 1997 have been adjusted to properly reflect the
allocation of limited partners' and General Partners' capital in anticipation of
the liquidation of the Partnership.
B. Related Parties
 
   PBP and its affiliates perform services for the Partnership which include,
but are not limited to: accounting and financial management, transfer and
assignment functions, asset management (including direct management of the
Partnership's unimproved property), investor communications, printing and other
administrative services. PBP and its affiliates receive reimbursements for costs
incurred in connection with these services, the amount of which is limited by
the provisions of the Partnership Agreement. The costs and expenses incurred on
behalf of the Partnership which are reimbursable to PBP and its affiliates for
the nine and three months ended June 30, 1996 were approximately $96,000 and
$35,000, respectively.
   Affiliates of Messrs. Watson and Taylor, the individual General Partners,
also perform certain administrative and monitoring functions on behalf of the
Partnership. The Partnership recorded approximately $24,000 and $18,000 for the
nine and three months ended June 30, 1996, respectively, relating to the
reimbursement of these services.
   Estimated liquidation costs payable to the General Partners and their
affiliates were approximately $129,000 as of June 30, 1997.
   PBP and the two individual General Partners of the Partnership own 270, 135
and 135 equivalent limited partnership units, respectively. PBP receives funds
from the Partnership, such as General Partner distributions and reimbursement of
expenses, but has waived all of its rights resulting from its ownership of
equivalent limited partnership units. Accordingly, the 270 units owned by PBP
have been excluded from the calculation of net income per limited partnership
unit and distributions per limited partnership unit.
   Prudential Securities Incorporated, an affiliate of PBP, owns 253 limited
partnership units at June 30, 1997.
C. Contingencies
 
   On March 5, 1997, a lawsuit captioned Madison Partnership Liquidity Investors
VIII, LLC ('Madison') v. Prudential-Bache Properties, Inc. was filed in the
Court of Chancery in the State of Delaware. The suit alleges a breach of
contract with Madison and a breach of fiduciary duty to Madison, as well as
intentional interference with the contract between Madison and the purported
tendering limited partners. The suit seeks injunctive and declaratory relief
demanding that the Partnership's transfer agent effectuate the purported
transfers to Madison, pursuant to the tender offer made by Madison to the
limited partners. The lawsuit does not name the Partnership as a defendant but
does name the Partnership's Managing General Partner. The distribution amounts
in excess of Madison's tender offer price, with respect to the units that are
the subject of this lawsuit, have been escrowed by the Partnership's transfer
agent. The case was settled as of July 25, 1997. The settlement resolves the
issues presented by the litigation without payment of monetary consideration.
Upon completion of certain actions by the parties, the case will be dismissed
with prejudice.
                                       5
<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
           ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                      CONDITION AND RESULTS OF OPERATIONS
 
Liquidity and Capital Resources
 
   In accordance with the Consent Statement dated September 17, 1996, the
limited partners approved, on October 18, 1996, the sale to Public Storage, Inc.
of all seven miniwarehouse facilities owned by the Partnership and the
liquidation and dissolution of the Partnership. The properties were sold to
Public Storage, Inc. and its affiliates on October 31, 1996. The partnership
continues to own an undeveloped land parcel (I35/I20) located in Dallas, Texas.
It is uncertain at this time as to when the sale of this property will occur.
 
   A distribution of $180 per limited partnership unit was made on November 14,
1996 representing the net sales proceeds reduced by a contingency reserve and
funds required to meet the anticipated current and future operating costs until
the liquidation of the Partnership. The Partnership intends to liquidate in
1997, subject to the prior sale of the remaining undeveloped land parcel, and
will distribute any remaining funds at such time. In accordance with the
Partnership Agreement, such distributions to partners will be made based upon
each partner's capital account for Federal income tax purposes. Estimated costs
expected to be incurred through the date of liquidation of the Partnership have
been accrued in the accompanying financial statements.
 
Results of Operations
 
   As a result of the Partnership adopting the liquidation accounting in
accordance with generally accepted accounting principles as of October 1, 1996
and thus not reporting results of operations thereafter, there is no management
discussion comparing the corresponding 1997 and 1996 periods.
 
                                       6
<PAGE>
                           PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings--This information is incorporated by reference to Note
        C to the financial statements filed herewith in Item 1 of Part I of the
        Registrant's Quarterly Report.
 
Item 2. Changes in Securities--None
 
Item 3. Defaults Upon Senior Securities--None
 
Item 4. Submission of Matters to a Vote of Security Holders--None
 
Item 5. Other Information--None
 
Item 6. Exhibits and Reports on Form 8-K
 
        (a) Exhibits
 
        Description:
 
        3.01 Amended and Restated Certificate and Agreement of Limited
             Partnership (filed as an exhibit to Registration Statement on Form
             S-11 (No. 2-94976) and incorporated herein by reference)
 
        3.02 Amendment to the Amended and Restated Certificate and
             Agreement of Limited Partnership (filed as an exhibit to
             Registrant's Form 10-K for the year ended September 30, 1989
             and incorporated herein by reference)
 
        4.01 Certificate of Limited Partnership Interest (filed as an
             exhibit to Registration Statement on Form S-11 (No.
             2-94976) and incorporated herein by reference)
 
        27.1 Financial Data Schedule (filed herewith)

        (b) Reports on Form 8-K--None
 
                                       7
<PAGE>
                              SIGNATURES
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, 
the Registrant has duly caused this report to be signed on its behalf 
by the undersigned thereunto duly authorized.

Prudential-Bache/Watson & Taylor, Ltd.-3
 
By: Prudential-Bache Properties, Inc. 
    A Delaware corporation,
    Managing General Partner
 
By: /s/ Eugene D. Burak                      Date: August 14, 1997
   ----------------------------------------
   Eugene D. Burak
   Vice President
   Chief Accounting Officer for the Registrant
 
                                       8