<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                -----------------

                                    FORM 10-K

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

                   For the fiscal year ended December 31, 1997
                           Commission File No. 0-17809
          -------------------------------------------------------------


             COPLEY REALTY INCOME PARTNERS 3; A LIMITED PARTNERSHIP

             (Exact name of registrant as specified in its charter)


       Massachusetts                                           04-3005973
(State or other jurisdiction of                             (I.R.S. Employer
incorporation or organization)                              Identification No.)

    225 Franklin Street, 25th Floor
    Boston, Massachusetts                                         02110
(Address of principal executive offices)                        (Zip Code)

               Registrant's telephone number, including area code:
                                 (617) 261-9000

           Securities registered pursuant to Section 12(b) of the Act:
                                      None

           Securities registered pursuant to Section 12(g) of the Act:
                      Units of Limited Partnership Interest

                                (Title of Class)

         Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                  Yes X   No ___

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) 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]

         No voting stock is held by nonaffiliates of the Registrant.

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      None
<PAGE>
 
                                    PART I


Item 1.       Business.

              Copley Realty Income Partners 3; A Limited Partnership (the
"Partnership") was organized under the Uniform Limited Partnership Act of the
Commonwealth of Massachusetts on February 17, 1988, to invest primarily in newly
constructed and existing income-producing real properties.

              The Partnership was initially capitalized with contributions of
$2,000 in the aggregate from Third Income Corp. (the "Managing General Partner")
and GCOP Associates Limited Partnership (the "Associate General Partner")
(collectively, the "General Partners") and $10,000 from Copley Real Estate
Advisors, Inc. (the "Initial Limited Partner"). The Partnership filed a
Registration Statement on Form S-11 (the "Registration Statement") with the
Securities and Exchange Commission on February 23, 1988, with respect to a
public offering of 40,000 units of limited partnership interest at a price of
$1,000 per unit (the "Units") with an option to sell up to an additional 60,000
Units (an aggregate of $100,000,000). The Registration Statement was declared
effective on May 23, 1988.

              The first sale of Units occurred on October 13, 1988, at which
time the Initial Limited Partner withdrew its contribution from the Partnership.
Investors were admitted to the Partnership thereafter at monthly closings; the
offering terminated and the last group of initial investors was admitted to the
Partnership on June 6, 1989. As of June 6, 1989, a total of 27,641 Units had
been sold, a total of 1,703 investors had been admitted as limited partners (the
"Limited Partners") and a total of $27,140,580 had been contributed to the
capital of the Partnership. The remaining 72,359 Units were de-registered on
June 27, 1989.

              As of December 31, 1997, the Partnership is invested in the two
real property investments described below. In addition, The Partnership sold one
property during 1997. The Partnership has no current plan to renovate, improve
or further develop any of its real property. In the opinion of the Managing
General Partner of the Partnership, the properties are adequately covered by
insurance. The principal terms of the sale of the Partnership's investment are
set forth in the following table:

<TABLE> 
<CAPTION> 

 Investment      Month/Year of Sale  Net Sale Proceeds  Distribution/Unit Distribution
                                                                           Month/Year
<S>                   <C>             <C>                <C>                 <C> 
Investment Three      7/97            $5,715,415         $200.00             7/97
</TABLE> 

              The Partnership  has no employees.  Services are performed for the
Partnership  by the  Managing  General  Partner and  affiliates  of the Managing
General Partner.

              A.  Industrial Building in Brea, California ("Brea West")

                  On April 28, 1989, the Partnership  acquired a 60% interest in
a joint venture formed with an affiliate of The Muller Company.  The Partnership
committed to contribute  $8,250,000 to the capital of the joint venture,  all of
which was funded. On December 20, 1990, the Partnership increased its investment
in the joint  venture by committing to make a deficit loan to the venture in the
maximum  amount  of  $900,000,  of  which  $828,799  was  funded.   Because  the
Partnership's  joint  venture  partner was unable to fund its share of deficits,
the Partnership assumed 100% ownership of the joint venture's assets,  effective
June 30, 1991. The property  consists  primarily of approximately  7.51 acres of
land in Brea,  California and a 184,000 square foot industrial  facility located
thereon.  As of December  31,  1997,  the facility was 100% leased to one tenant
until May 2008.
<PAGE>
 
              B.  Industrial Building in Simi Valley, California ("Shasta Way")

                  On September 29, 1989, the Partnership acquired a 34.8%
interest in a joint venture formed with Copley Realty Income Partners 4; A
Limited Partnership, an affiliate of the Partnership (the "Affiliate") with a
25.2% interest, and an affiliate of The Hewson Company (the "Developer"). As of
December 31, 1997, the Partnership had contributed $7,111,757 to the capital of
the joint venture out of a maximum commitment of $7,612,500. Effective January
1, 1996, the joint venture was restructured resulting in the withdrawal of the
Developer, and the increase of the ownership interests of the Partnership and
its Affiliate to 58% and 42%, respectively. The joint venture agreement entitled
the Partnership and the Affiliate to receive a preferred return on their
respective invested capital at the rate of 10% per annum. The joint venture
agreement also entitles the Partnership to receive 58% of remaining cash flow
and 58% of sale and refinancing proceeds following the return of the
Partnership's and the Affiliate's equity.

                  The joint venture owns approximately 12.13 acres of land in
Simi Valley, California and in June 1991 completed construction thereon of a
235,080 square foot industrial building. As of December 31, 1997, the facility
was 100% leased to one tenant until December 1998. The lease includes two five-
year renewal options.
<PAGE>
 
Item 2.       Properties.


     The   following   table  sets  forth  the  annual   realty  taxes  for  the
Partnership's  properties and  information  regarding  tenants who occupy 10% or
more of gross leasable area (GLA) in the Partnership's properties:

<TABLE>
<CAPTION>

------------------------------------------------------------------------------------------------------------------------------------

                                   Estimated
                                      1998                                                              Annual
             Property                Annual        Number of                                           Contract
                                     Realty    Tenants with 10%       Name(s) of       Square Feet of    Rent         Lease        
                                     Taxes       or More of GLA        Tenant(s)         Each Tenant   Per S. F.   Expiration      
-----------------------------------------------------------------------------------------------------------------------------------

<S>                                <C>         <C>                <C>                 <C>              <C>         <C>             
Industrial Building in Brea, CA     $81,568            1          Nature's Best           184,000        $4.50       5/2008         

Industrial Building in Simi                                                                                                      
Valley, CA                          $106,243           1          Bugle Boy               235,080        $4.87      12/1998      
                                                                  Industries                                                        
-----------------------------------------------------------------------------------------------------------------------------------

------------------------------------------------------------------------------------------------------------------------------------


                                   
                                   Renewal                 Line of Business
                                   Options               of Principal Tenants
--------------------------------------------------------------------------------
<S>                                <C>                   <C>                  
Industrial Building in Brea, CA    None                  Health Food Distributor
Industrial Building in Simi         
Valley, CA                         Two 5-year options    Apparel Manufacturer
</TABLE>
<PAGE>
 
              The following table sets forth for each of the last five years the
gross leasable areas, occupancy rates, rental revenue and net effective rent for
the Partnership's properties:

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------
                                                                         Net
                                                            Rental    Effective
                         Gross-Leasable       Year-End     Revenue       Rent
     Property                 Area            Occupancy   Recognized  ($/sf/yr)*
--------------------------------------------------------------------------------
<S>                      <C>                  <C>         <C>         <C>  

Industrial Building in 
  Brea, CA
                  1993       184,000            100%       $  977,076   $5.31
                  1994       184,000            100%       $  995,209   $5.41
                  1995       184,000            100%       $1,001,985   $5.45
                  1996       184,000            100%       $1,023,187   $5.56
                  1997       184,000            100%       $  951,224   $5.17

Industrial Building in
  Simi Valley, CA
                  1993       235,080             80%         $863,430   $6.12
                  1994       235,080            100%       $1,157,494   $5.28
                  1995       235,080            100%       $1,163,851   $4.95
                  1996       235,080            100%       $1,208,205   $5.14
                  1997       235,080            100%       $1,205,152   $5.13

---------------------------------------------------------------------------------
</TABLE>

* Net  Effective  Rent  calculation  is based on  average  occupancy  during the
respective year.
<PAGE>
 
              Set forth below is a schedule of lease expirations for each of the
next ten years for the  Partnership's  properties  based on the annual  contract
rent in effect at December 31, 1997:

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------
                          TENANT AGING REPORT

    Property            # of Lease      Total          Total       Percentage of
                       Expirations   Square Feet       Annual       Gross Annual
                                                   Contract Rent*      Rental
--------------------------------------------------------------------------------
<S>                     <C>          <C>           <C>             <C>    
Industrial Building in 
  Brea, CA
               1998           0             0               $0               0%
               1999           0             0               $0               0%
               2000           0             0               $0               0%
               2001           0             0               $0               0%
               2002           0             0               $0               0%
               2003           0             0               $0               0%
               2004           0             0               $0               0%
               2005           0             0               $0               0%
               2006           0             0               $0               0%
               2007**         0             0               $0               0%

Industrial Building in 
  Simi Valley, CA
               1998           1       235,080       $1,188,000             100%
               1999           0             0               $0               0%
               2000           0             0               $0               0%
               2001           0             0               $0               0%
               2002           0             0               $0               0%
               2003           0             0               $0               0%
               2004           0             0               $0               0%
               2005           0             0               $0               0%
               2006           0             0               $0               0%
               2007           0             0               $0               0%

</TABLE>
------------------------------
*  Does not include expenses paid by tenants.
** Sole tenant's lease expires May, 2008.
<PAGE>
 
           The  following  table  sets  forth  for  each  of  the  Partnership's
properties the: (i) federal tax basis,  (ii) rate of depreciation,  (iii) method
of  depreciation,  (iv) life claimed,  and (v)  accumulated  depreciation,  with
respect to each property or component thereof for purposes of depreciation:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
Depreciable Assets           
                                                     Rate of                      Life             Accumulated
    Entity / Property               Tax Basis      Depreciation      Method      in years         Depreciations
<S>                                 <C>            <C>               <C>         <C>              <C>
Brea West                    
-------------------------

Building & Improvements             $ 5,673,186    3.17%             SL          31.5             $ 1,274,915
Land Improvements                        70,337    6.67%             SL            15                  29,155
                                    -----------    -----                                          -----------
Total Depreciable Assets              5,743,523                                                     1,304,070
                             
Shasta Way                   
-------------------------
Building & Improvements               6,643,803    3.17%             SL          31.5               1,287,465
                                    -----------    -----                                          -----------
Total Depreciable Assets              6,643,803                                                     1,287,465
                             
Total Depreciable Assets            $12,387,326                                                   $ 2,591,535
                                    ===========                                                   ===========
----------------------------------------------------------------------------------------------------------------
</TABLE>
SL = Straight-Line
<PAGE>
 
                  Following is information regarding the competitive market
conditions for each of the Partnership's properties. This information has been
gathered from sources deemed reliable. However, the Partnership has not
independently verified the information and, as such, cannot guarantee its
accuracy or completeness:

              A.  Industrial Building in Brea, CA.

                  The property is located within the Orange County industrial
market. Brea is a desirable industrial location due to its close proximity to
Los Angeles County and the central portion of Orange County. The North Orange
County market has approximately 7.6 million square feet of space available, an
increase which is primarily due to the completion of more than 35 new industrial
buildings, adding over 2.6 million square feet of new space to the market. In
addition, another 54 buildings should be completed by year-end 1998, adding
approximately twice the square footage added during 1997. Average asking rental
rates over the last year have increased 19%, with average vacancy in the county
of 7.11%.


              B.  Industrial Building in Simi Valley, CA.

                  The property is located within the greater Los Angeles
industrial market. During 1997, the supply and demand balance in the Los Angeles
industrial market remained in equilibrium while the years of supply grew from
2.2 years in 1996 to 2.7 years in 1997. Industrial demand in the Los Angeles
County metropolitan area during 1997 was 1.8%, a decrease from the 3.1% recorded
in 1996. The 1997 industrial vacancy rate at year-end 1997 was 6.7%, an
improvement from the 8.2% rate recorded at the close of 1996. Also indicative of
the metro area's improving economy is a falling jobless rate, which recently
declined to 6.3%.

Item 3.       Legal Proceedings.

              The Partnership is not a party to, nor are any of its properties
subject to, any material pending legal proceedings.

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

              No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.
<PAGE>
 
                                     PART II


     Item 5.  Market for Registrant's Common Equity and Related Stockholder
Matters.
              There is no active market for the Units. Trading in the Units is
sporadic and occurs solely through private transactions.

              As of December 31, 1997, there were 1,752 holders of Units.

              The Partnership's Amended and Restated Agreement of Limited
Partnership dated October 13, 1988, as amended to date (the "Partnership
Agreement"), requires that any Distributable Cash (as defined therein) be
distributed quarterly to the Partners in specified proportions and priorities.
There are no restrictions on the Partnership's present or future ability to make
distributions of Distributable Cash. For the year ended 1997, cash distributions
paid in 1997, or distributed after year end with respect to 1997 to the Limited
Partners as a group totaled $7,225,081, including $5,528,200 ($200 per limited
partnership unit), representing proceeds from the sale of one property. For the
year ended December 31, 1996, cash distributions paid in 1996, or distributed
after year end with respect to 1996 to the Limited Partners as a group totaled
$1,658,460.

              Largely due to the capital distribution mentioned above, total
cash distributions exceeded net income in 1997 and, therefore, resulted in a
reduction of partners' capital. Regular cash distributions from operations also
exceeded cash provided by operating activities in 1997. Reference is made to the
Partnership's Statement of Partners' Capital (Deficit) and Statement of Cash
Flows in Item 8 hereof.
<PAGE>
 
Item 6.       Selected Financial Data.

<TABLE> 
<CAPTION> 
                             For Year            For Year         For Year           For Year             For Year
                             Ended or            Ended or         Ended or           Ended or             Ended or
                             As of:                As of:           As of:             As of:                As of:
                             12/31/97 (2)        12/31/96         12/31/95          12/31/94 (1)           12/31/93
                           ------------        -----------      -------------      -----------           -----------
<S>                        <C>                 <C>              <C>                <C>                   <C>  
Revenues                    $ 1,673,318        $ 1,993,178      $   1,749,606      $ 1,650,992           $ 1,411,498

Net Income (Loss)           $ 2,303,492        $ 1,058,287      $   1,025,324      $(1,451,876)          $   681,269

Net Income (Loss)
per Limited
Partnership Unit            $     82.50        $     37.90      $       36.72      $    (52.00)          $     24.40


Total Assets                $14,687,268        $19,622,775      $  20,250,786      $20,750,350           $23,600,717


Total Cash
Distributions
per Limited
Partnership Unit,
including amounts
distributed after
year end with
respect to such
year                       $     261.39        $     60.00      $       57.50      $     50.00           $     50.00
                           ------------        -----------      -------------      -----------           -----------
</TABLE> 
(1)    Net Income (Loss) in 1994 includes a charge of $2,400,000 related to
       impairment of the carrying value of an investment.

(2)    Net Income in 1997 includes a gain from the sale of one property of
       $1,490,313. Cash Distributions include a return of capital of $200.00 per
       Limited Partnership Unit.
<PAGE>
 
Item 7.

Management's Discussion and Analysis of Financial Condition and Results of
Operations

Liquidity and Capital Resources

         The Partnership completed its offering of units of limited partnership
interest in June 1989 and a total of 27,641 units were sold. The Partnership
received proceeds of $24,458,317, net of selling commissions and other offering
costs, which have been used for investments in real estate, related acquisition
costs, or were retained as working capital reserves.

         On July 22, 1997, the South Bay property was sold to the sole tenant
which exercised the purchase option under its lease for gross consideration of
$5,850,000. The Partnership received net proceeds of $5,715,415, after closing
costs, and recognized a gain of $1,490,313 ($53.38 per limited partnership unit)
on the sale. A disposition fee of $29,250 was accrued but not paid to AEW Real
Estate Advisors, Inc. ("AEW"). On July 24, 1997, the Partnership made a capital
distribution of $5,528,200 ($200 per limited partnership unit) from the proceeds
of the sale. This distribution reduced the adjusted capital contribution to $800
per unit.

         At December 31, 1997, the Partnership had $2,300,625 in cash, cash
equivalents, and short-term investments, of which $390,883 was used for cash
distributions to partners on January 29, 1998; the remainder is being retained
for working capital reserves. The source of future liquidity and cash
distributions to partners will be cash generated by the Partnership's real
estate and short-term investments. Distributions of cash from operations
relating to all four quarters of 1996 were made at the annualized rate of 6.0%
on a capital contribution of $1,000 per unit. The annualized distribution rate
for the first two quarters of 1997 was increased to 6.5%, and then increased
again, to 7.0%, for the third and fourth quarters. The third quarter 1997
distribution was based on the weighted average adjusted capital contribution.
The fourth quarter 1997 distribution was based on the adjusted capital
contribution of $800. The two increases in the distribution rate this year were
due to increased cash flow from Shasta Way, combined with the reduction in the
adjusted capital contribution as a result of the South Bay sale.

         The carrying value of real estate investments in the financial
statements at December 31, 1997 is at depreciated cost, or if the investment's
carrying value is determined not to be recoverable through expected undiscounted
future cash flows, the carrying value is reduced to estimated fair market value.
The fair market value of such investments is further reduced by the estimated
costs of sale for properties held for sale. Carrying value may be greater or
less than current appraised value. At December 31, 1997, the aggregate appraised
value of the Partnership's investments was approximately $2,400,000 greater than
their aggregate carrying value. The current appraised value of real estate
investments has been estimated by the Managing General Partner and is generally
based on a combination of traditional appraisal approaches performed by AEW and
independent appraisers. Because of the subjectivity inherent in the valuation
process, the current appraised value may differ significantly from that which
could be realized if the real estate were actually offered for sale in the
marketplace.

         The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Partnership's computer programs that have date-sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions or
engage in normal business operations. The Managing General Partner and its
affiliates are assessing the modifications or replacements of its software that
may be required due to the Year 2000 Issue.

<PAGE>
 
The Managing General Partner and its affiliates do not believe that the cost of
either modifying existing software or converting to new software will be
significant or that the Year 2000 Issue will pose significant operational
problems.

Results of Operations

         Form of Real Estate Investments

         The Brea West investment is a wholly-owned property. The South Bay
investment was structured as a joint venture with a real estate
management/development firm. Effective January 1, 1996, however, the venture was
restructured and the venture partner's ownership interest was assigned to the
Partnership. Accordingly, as of that date, this investment was accounted for as
a wholly-owned property. The South Bay investment was sold on July 22, 1997, as
discussed above. The Shasta Way investment had been structured as a joint
venture with a real estate management/development firm and an affiliate of the
Partnership. As of January 1, 1996, the ownership was restructured, and the
management/development firm's interest was assigned to the Partnership and its
affiliate in proportion to their respective ownership interests. The
Partnership's ownership percentage increased to 58%.

         Operating Factors

         The Brea West property was 100% leased to a single tenant at December
31, 1997, 1996 and 1995. Base rent increased in October 1995, in accordance with
the terms of the lease agreement. A new 11-year lease was signed with the tenant
at Brea West which commenced on September 1, 1997 at a slightly lower rental
rate.

         The South Bay property was 100% leased to a single tenant through the
sale date of July 22, 1997. The lease term began in May, 1994 for 83% of the
building for the first year, and 100% of the building thereafter through
September, 2001.

         The Shasta Way venture completed the construction of its industrial
facility in 1991. A lease was executed for 80% of the building commencing April
1, 1993, and as of May 1, 1994, the tenant leased the entire building through
December 31, 1998.

         Three tenants each contributed more than 10% of the rental revenue from
the Partnership's investments (collectively 100%) for 1997. The two sole tenants
at Brea West and Shasta Way were current with regard to lease payments at
December 31, 1997; management is not aware of any impairment in the tenants'
ability to continue to perform in accordance with the terms of their respective
leases.

         Investment Results

         1997 Compared to 1996

         Aggregate operating results from real estate investments were $965,851
and $1,222,744 in 1997 and 1996, respectively. The decline was primarily due to
the sale of the South Bay property in July 1997, resulting in decreased
operating income of approximately $158,000. In addition, at Brea West, write-
offs of tenant concessions and lease commissions related to the old lease, as
well as lower rental revenue under the new lease, accounted for approximately
$85,000 of the decrease in operating results between the two years.
<PAGE>
 
         Interest on cash equivalents and short-term investments increased by
$14,000 or 13%, due to higher average invested balances, as well as higher 
short-term yields.

         Cash provided by operations decreased by approximately $306,000 between
1996 and 1997. The difference is attributable to the decrease in operating
results discussed above, and to the funding of $163,000 in commissions related
to the new lease at Brea West. These decreases were partially offset by the
timing of distributions from Shasta Way.

         1996 Compared 1995

         Aggregate real estate operating results were $1,222,744 and $1,176,705
in 1996 and 1995, respectively. Operating income increased at each of the three
properties. Brea West increased by $10,000, as an increase in rental income was
partially offset by an increase in repairs and maintenance expenses. South Bay
increased by $18,000 due to a decrease in operating expenses. At Shasta Way,
operating income increased by $16,000, primarily due to a rental increase in
October 1995, partially offset by higher accounting fees.

         Interest on cash equivalents and short-term investments decreased by
$12,000 or 10%, primarily due to a decrease in short-term yields, partially
offset by higher average invested balances.

         Cash flow provided by operations increased by approximately $171,000
primarily due to improved investment results and the timing of cash
distributions from Shasta Way and South Bay, as well as changes in property
working capital.

         Portfolio Expenses

         General and Administrative expenses primarily consist of appraisal,
printing, accounting, legal and servicing agent fees. These expenses decreased
approximately $2,000, or 2% between 1996 and 1997, primarily due to a decrease
in appraisal fees partially offset by increases in franchise taxes, and investor
servicing fees. General and administrative expenses decreased $6,000, or 5%
between 1995 and 1996, primarily due to decreases in legal and professional
fees. The Partnership management fee is 9% of distributable cash flow from
operations after any increase or decrease in working capital reserves, as
determined by the Managing General Partner. Management fees increased in 1996
and 1997 due to the increases in distributable cash flow.

Inflation

         By their nature, real estate investments tend not be adversely affected
by inflation. Inflation may result in appreciation in the value of the
Partnership's real estate investments over time, if rental rates and replacement
costs increase. Declines in real property values during the period of
Partnership operations, due to market and economic conditions, have overshadowed
the positive effect inflation may have on the value of the Partnership's
investments.
<PAGE>
 
Item 8.       Financial Statements and Supplementary Data.

              See the Financial Statements of the Partnership included as a part
              of this Annual Report on Form 10-K.

Item 9        Disagreements on Accounting and Financial Disclosure.

              The Partnership has had no disagreements with its accountants on
any matters of accounting principles or practices or financial statement
disclosure.


                                   PART III

Item 10.   Directors and Executive Officers of the Registrant.

           (a) and (b) Identification of Directors and Executive Officers.

The following table sets forth the names of the directors and executive officers
of the Managing General Partner and the age and position held by each of them as
of December 31, 1997.

<TABLE> 
<CAPTION> 

Name                           Position(s) with the Managing General Partner                            Age
<S>                            <C>                                                                      <C> 
Wesley M. Gardiner, Jr.        President, Chief Executive Officer and Director                          39
Pamela J. Herbst               Vice President and Director                                              42
J. Grant Monahon               Vice President and Director                                              52
James J. Finnegan              Vice President                                                           37
Karin J. Lagerlund             Treasurer and Principal Financial and Accounting Officer                 33
</TABLE> 

           (c)    Identification of Certain Significant Employees.

                  None.

           (d)    Family Relationships.

                  None.

           (e)    Business Experience.

                  The Managing General Partner was incorporated in Massachusetts
on February 17, 1988. The background and experience of the executive officers
and directors of the Managing General Partner are as follows:

         Wesley M. Gardiner, Jr. joined AEW Real Estate Advisors, Inc. ("AEW"),
formerly known as Copley Real Estate Advisors, Inc., in 1990 and has been a Vice
President at AEW since January, 1994. AEW is a subsidiary of AEW Capital
Management, L.P. ("AEW Capital Management"). From 1982 to 1990, he was employed
by Metric Realty, a nationally-known real estate investment advisor and
syndication firm, as a portfolio manager responsible for several public and
private limited partnerships. His career at AEW has included asset management
responsibility for the company's Georgia and Texas holdings. Presently, Mr.
Gardiner has overall responsibility for all the partnerships advised by AEW
whose securities are registered under the Securities and Exchange Act of 1934.
He received a B.A. in Economics from the University of California at San Diego.
<PAGE>
 
         Pamela J. Herbst directs AEW Capital Management's Portfolio Advisory
Services, with oversight responsibility for the asset and portfolio management
areas. Ms. Herbst is a member of AEW Capital Management's Investment Policy
Group and Management Committee. She came to AEW Capital Management in December
1996 as a result of the firm's merger with Copley Real Estate Advisors, Inc.,
where she held various senior level positions in asset and portfolio management,
acquisitions, and corporate operations since 1982. Ms. Herbst is a graduate of
the University of Massachusetts (B.A.) and Boston University (M.B.A.).

         J. Grant Monahon is AEW Capital Management's General Counsel and a
member of the firm's Management Committee and Investment Policy Group. He has
over 25 years of experience in real estate law and investments. Prior to joining
AEW Capital Management in 1987, Mr. Monahon was a partner with a major Boston
law firm. As the head of that firm's real estate finance department, he
represented a wide variety of institutional clients, both domestic and
international, in complex equity and debt transactions. He is the former
Chairman of the General Counsel section of the National Association of Real
Estate Investment Managers. Mr. Monahon is a graduate of Dartmouth College
(B.A.) and Georgetown University Law Center (J.D.).

         James J. Finnegan is the Assistant General Counsel of AEW Capital
Management. Mr. Finnegan served as Vice President and Assistant General Counsel
of Aldrich, Eastman & Waltch, L.P., a predecessor to AEW Capital Management. Mr.
Finnegan has over ten years of experience in real estate law, including seven
years of experience in private practice with major New York City and Boston law
firms. Mr. Finnegan also serves as AEW's securities and regulatory compliance
officer. Mr. Finnegan is a graduate of the University of Vermont (B.A.) and
Fordham University School of Law (J.D.).

         Karin J. Lagerlund directs the Advisory Services Portfolio Accounting
Group at AEW Capital Management, overseeing portfolio accounting, performance
measurement and client financial reporting for AEW's private equity investment
portfolios. Ms. Lagerlund is a Certified Public Accountant and has over ten
years experience in real estate consulting and accounting. Prior to joining AEW
Capital Management in 1994, she was an Audit Manager at EY/Kenneth Leventhal
LLP. Ms. Lagerlund is a graduate of Washington State University (B.A.).

(f)      Involvement in Certain Legal Proceedings.

         None.

Item 11.      Executive Compensation.

              Under the Partnership Agreement, the General Partners and their
affiliates are entitled to receive various fees, commissions, cash
distributions, allocations of taxable income or loss and expense reimbursements
from the Partnership. See Notes 1 and 6 of Notes to Financial Statements.
<PAGE>
 
              The following table sets forth the amounts of the fees and cash
distributions and reimbursements of out-of-pocket expenses which the Partnership
paid to or accrued for the account of the General Partners and their affiliates
for the year ended December 31, 1997. Cash distributions to General Partners
include amounts distributed after year-end with respect to 1997.

<TABLE> 
<CAPTION> 

Receiving Entity                       Type of Compensation                       Amount of Compensation
                                                                                    and Reimbursement
<S>                                    <C>                                        <C> 

AEW Real Estate Advisors, Inc.         Management Fees and Reimbursement of                               
                                       Expenses                                               $   181,519 

General Partners                       Share of Distributable Cash                                 17,140

New England Securities Corporation     Servicing Fees and Reimbursement of                                
                                       Expenses                                                     2,834 

Back Bay Advisors, L.P.                Servicing Fee                                                1,726
                                                                                               ----------

                                       TOTAL                                                   $  203,219
                                                                                               ==========
</TABLE> 

         For the year ended December 31, 1997, the Partnership  allocated $3,782
of taxable income to the General Partners.

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

              (a)  Security Ownership of Certain Beneficial Owners.

              As of December 31, 1997, Alexander Hamilton Life Insurance Company
of America, whose address is 2700 Sanders Road, Prospect Heights, IL., 60070,
owned 5,000 Units, approximately 18% of the total number of Units outstanding.
No other person or group is known by the Partnership to be the beneficial owner
of more than 5% of the outstanding Units at December 31, 1997. Under the
Partnership Agreement, the voting rights of the Limited Partners are limited
and, in some circumstances, are subject to the prior receipt of certain opinions
of counsel or judicial decisions.

              Except as expressly provided in the Partnership Agreement, the
right to manage the business of the Partnership is vested exclusively in the
Managing General Partner.

              (b) Security Ownership of Management.

                  The General Partners of the Partnership owned no Units at
December 31, 1997.

              (c) Changes in Control.

                  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 Partnership has no relationships or transactions to report
other than as reported in Item 11, above.
<PAGE>
 
                                    PART IV

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

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

                  (1) Financial Statements--The Financial Statements listed on
the accompanying Index to Financial Statements and Schedule and Financial
Statements Index No. 2 are filed as part of this Annual Report.

                  (2) Financial Statement Schedules--The Financial Statement
Schedule listed on the accompanying Index to Financial Statements and Schedule
is filed as part of this Annual Report.

                  (3) Exhibits--The Exhibits listed in the accompanying Exhibit
Index are filed as a part of this Annual Report and incorporated in this Annual
Report as set forth in said Index.

              (b) Reports on Form 8-K. No Current Reports on Form 8-K were filed
during the fourth quarter of 1997.
<PAGE>
 
                       Copley Realty Income Partners 3;
                             A Limited Partnership











                             Financial Statements


                                 * * * * * * *







                               December 31, 1997
<PAGE>
 
                       COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP

                  INDEX TO FINANCIAL STATEMENTS AND SCHEDULE





         Report of Independent Accountants

         Financial Statements

                  Balance Sheets - December 31, 1997 and 1996

                  Statements of Operations - For the Years Ended December 31,
                   1997, 1996 and 1995

                  Statement of Partners' Capital (Deficit) - For the Years Ended
                   December 31, 1997, 1996 and 1995

                  Statements  of Cash Flows - For the Years Ended  December  31,
                   1997, 1996 and 1995

                  Notes to Financial Statements

         Financial Statement Schedule:

                  Schedule III - Real  Estate and  Accumulated  Depreciation  at
                   December 31, 1997, 1996 and 1995
<PAGE>
 
                       Report of Independent Accountants


To the Partners

Copley Realty Income Partners 3;
A Limited Partnership

In our opinion, based on our audits and the reports of other auditors for the
years ended December 31, 1997, 1996 and 1995, the financial statements listed in
the accompanying index present fairly, in all material respects, the financial
position of Copley Realty Income Partners 3; A Limited Partnership (the
"Partnership") at December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of Third Income Corp., the Managing
General Partner of the Partnership; our responsibility is to express an opinion
on these financial statements based on our audits. We did not audit the
financial statements of the Partnership's Shasta Way joint venture investee for
the years ended December 31, 1996 and 1995 which results of operations are
recorded using the equity method of accounting in the Partnership's financial
statements. Equity in joint venture income for Shasta Way was $328,348 and
$312,772 for the years ended December 31, 1996 and 1995, respectively. We also
did not audit the financial statements of the Partnership's investment in South
Bay Associates for the years ended December 31, 1996 and 1995. Operating income
for this investment totalled $431,682 for the year ended December 31, 1996 and
equity in joint venture income was $315,789 for the year ended December 31,
1995. We also did not audit the financial statements of Brea West, a wholly-
owned property, for the years ended December 31, 1996 and 1995, which statements
reflect operating income of $891,127 and $880,763 for the years then ended.
Those statements were audited by other auditors whose reports thereon have been
furnished to us, and our opinion expressed herein, insofar as it relates to the
amounts included for the equity in joint venture income for Shasta Way for the
years ended December 31, 1996 and 1995, for the operating income and equity in
joint venture income for South Bay Associates for the years ended December 31,
1996 and 1995, and for operating income for Brea West for the years ended
December 31, 1996 and 1995, is based solely on the reports of the other
auditors. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by the
Managing General Partner, and evaluating the overall financial statement
presentation. We believe that our audits and the reports of other auditors for
the years ended December 31, 1997, 1996 and 1995 provide a reasonable basis for
the opinion expressed above.






/s/ Price Waterhouse LLP
--------------------------
Boston, Massachusetts
March 23, 1998
<PAGE>
 
 COPLEY REALTY INCOME PARTNERS 3;
A LIMITED PARTNERSHIP

BALANCE SHEETS
<TABLE> 
<CAPTION> 

                                                                          December 31,
                                                            ----------------------------------------------
                                                                  1997                          1996
                                                            -----------------           ------------------        
<S>                                                         <C>                         <C> 
Assets

Real estate investments:
 Joint ventures                                             $       5,071,717           $        5,531,652
 Property, net                                                      7,314,926                   11,789,227
                                                            -----------------           ------------------
                                                                   12,386,643                   17,320,879

Cash and cash equivalents                                           2,101,633                    1,798,785
Short-term investments                                                198,992                      503,111
                                                            -----------------           ------------------
                                                            $      14,687,268           $       19,622,775
                                                            =================           ==================

Liabilities and Partners' Capital

Accounts payable                                            $          50,345           $           45,692
Accrued management fee                                                 38,659                       41,420
Deferred disposition fee                                               29,250                            -
                                                            -----------------           ------------------
Total liabilities                                                     118,254                       87,112
                                                            -----------------           ------------------

Partners' capital (deficit):
 Limited partners ($800 and $1,000 per unit,
  respectively; 100,000 units authorized;
  27,641 units issued and outstanding)                             14,610,376                   19,582,641
 General partners                                                     (41,362)                     (46,978)
                                                            -----------------           ------------------
Total partners' capital                                            14,569,014                   19,535,663
                                                            -----------------           ------------------

                                                            $      14,687,268           $       19,622,775
                                                            =================           ==================
</TABLE> 


                (See accompanying notes to financial statements)
<PAGE>
 
COPLEY REALTY INCOME PARTNERS 3;
A LIMITED PARTNERSHIP

STATEMENTS OF OPERATIONS

<TABLE> 
<CAPTION> 
                                                                          Year ended December 31,
                                                     ---------------------------------------------------------------
                                                           1997                   1996                  1995
                                                     -------------------    -----------------     ------------------
<S>                                                  <C>                    <C>                   <C> 
Investment Activity

Property rentals                                     $        1,234,451     $       1,559,843     $        1,003,979
Property operating expenses                                    (195,179)             (237,034)              (123,216)
Depreciation and amortization                                  (393,374)             (428,413)              (332,619)
                                                     -------------------    -----------------     ------------------
                                                                645,898               894,396                548,144

Joint venture earnings                                          319,953               328,348                628,561
                                                     ------------------     -----------------     ------------------

 Total real estate operations                                   965,851             1,222,744              1,176,705

 Gain on sale of property                                     1,490,313                    --                     --
                                                     ------------------     -----------------     ------------------

  Total real estate activity                                  2,456,164             1,222,744              1,176,705

Interest on cash equivalents
 and short-term investments                                     118,914               104,987                117,066
                                                     ------------------     -----------------     ------------------

   Total investment activity                                  2,575,078             1,327,731              1,293,771
                                                     ------------------     -----------------     ------------------

Portfolio Expenses

Management fee                                                  169,519               165,680                158,777
General and administrative                                      102,067               103,764                109,670
                                                     ------------------     -----------------     ------------------
                                                                271,586               269,444                268,447
                                                     ------------------     -----------------     ------------------

Net Income                                           $        2,303,492     $       1,058,287     $        1,025,324
                                                     ==================     =================     ==================

Net income  per limited
  partnership unit                                   $            82.50     $           37.90     $            36.72 
                                                     ==================     =================     ==================

Cash distributions per limited
  partnership unit                                    $          262.39     $           60.00     $            55.00 
                                                     ==================     =================     ==================

Number of limited partnership
  units outstanding during the year                              27,641                27,641                 27,641
                                                     ==================     =================     ==================
</TABLE> 


                (See accompanying notes to financial statements)
<PAGE>
 
COPLEY REALTY INCOME PARTNERS 3;
A LIMITED PARTNERSHIP

STATEMENT OF PARTNERS' CAPITAL (DEFICIT)

<TABLE> 
<CAPTION> 

                                                                    Year ended December 31,          
                                         ----------------------------------------------------------------------------
                                                           1997                                 1996                   
                                         ------------------------------------     -----------------------------------     
                                               General          Limited             General             Limited        
                                               Partners         Partners            Partners            Partners       
                                         --------------      ----------------     --------------    -----------------  
<S>                                      <C>                 <C>                  <C>               <C>                
Balance at beginning of year             $      (46,978)     $     19,582,641     $      (40,809)   $      20,193,397  
                                                                                                                       
Cash distributions                              (17,419)           (7,252,722)           (16,752)          (1,658,460) 
                                                                                                                       
Net income                                       23,035             2,280,457             10,583            1,047,704  
                                         --------------      ----------------     --------------    -----------------  
                                                                                                                       
Balance at end of year                   $      (41,362)     $     14,610,376     $      (46,978)   $      19,582,641  
                                         ===============     ================     ==============    =================  

                                                 Year Ended December 31, 
                                           ------------------------------------
                                                         1995
                                           ------------------------------------
                                               General            Limited
                                               Partners           Partners
                                           ----------------   -----------------
<S>                                        <C>                <C> 
Balance at beginning of year               $        (35,706)  $      20,698,581
                                         
Cash distributions                                  (15,356)         (1,520,255)
                                         
Net income                                           10,253           1,015,071
                                           ----------------   -----------------
                                         
Balance at end of year                     $        (40,809)  $      20,193,397
                                           ================   =================
</TABLE> 


                (See accompanying notes to financial statements)
<PAGE>
 
COPLEY REALTY INCOME PARTNERS 3;
A LIMITED PARTNERSHIP

STATEMENTS OF CASH FLOWS

<TABLE> 
<CAPTION> 
                                                                          Year ended December 31,
                                                    ------------------------------------------------------------------
                                                           1997                     1996                   1995
                                                    ------------------      ------------------     -------------------
<S>                                                 <C>                     <C>                    <C> 
Cash flows from operating activities:
 Net income                                         $       2,303,492       $        1,058,287     $         1,025,324
  Adjustments to reconcile net
     income to net cash provided
      by operating activities:
  Depreciation and amortization                               393,374                  428,413                 332,619
  Equity in joint venture net income                         (319,953)                (328,348)               (628,561)
  Cash distributions from joint ventures                      772,792                  694,437                 939,499
  Gain on sale of property                                 (1,490,313)                       -                     -
  Decrease (increase) in investment
      income receivable                                         4,492                     (681)                 (6,439)
  Increase (decrease) in operating
     liabilities                                                1,892                  (11,085)                 10,723
  Decrease (increase) in other net assets                    (107,829)                  22,751                  19,149
                                                    -----------------       ------------------     -------------------
           Net cash provided by operating        
             activities                                     1,557,947                1,863,774               1,692,314  
                                                    -----------------       ------------------     -------------------

Cash flows from investing activities:
 Net proceeds from sale of property                         5,686,165                        -                       -
 Deferred disposition fee                                      29,250                        -                       -
 Investment in property                                             -                 (186,836)                      -
 Investment in joint ventures                                       -                        -                 (68,687)
 Decrease (increase) in short-term
    investments, net                                          299,627                  101,879                (597,870)
                                                    -----------------       ------------------     -------------------
           Net cash provided by (used in) 
            investing activities                            6,015,042                  (84,957)               (666,557)

Cash flows from financing activity:
 Distributions to partners                                 (7,270,141)              (1,675,212)             (1,535,611)
                                                    -----------------       ------------------     -------------------
           Net cash used in financing activity             (7,270,141)              (1,675,212)             (1,535,611)
                                                    -----------------       ------------------     -------------------

Net increase (decrease) in cash and cash
 equivalents                                                  302,848                  103,605                (509,854)

Cash and cash equivalents
 Beginning of year                                          1,798,785                1,695,180               2,205,034
                                                    -----------------       ------------------     -------------------

 End of year                                        $       2,101,633       $        1,798,785     $         1,695,180
                                                    =================       ==================     ===================
</TABLE> 
<PAGE>
 
Non-cash transaction:

         Effective January 1, 1996, the Partnership's joint venture investment
in South Bay/CRIP 3 Associates was converted to a wholly-owned property. The
carrying value of this investment at conversion was $4,180,704.

               (See accompanying notes to financial statements)
<PAGE>
 
COPLEY REALTY INCOME PARTNERS 3;
A LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND BUSINESS

General

         Copley Realty Income Partners 3; A Limited Partnership (the
"Partnership") is a Massachusetts limited partnership organized for the purpose
of investing primarily in newly constructed and existing income-producing real
properties. The Partnership commenced operations in October 1988, and acquired
the two real estate investments it currently owns prior to the end of 1989. It
intends to dispose of its investments within nine years of their acquisition,
and then liquidate.

         The Managing General Partner of the Partnership is Third Income Corp.,
a wholly-owned subsidiary of AEW Real Estate Advisors, Inc. ("AEW"), formerly
known as Copley Real Estate Advisors ("Copley"). The associate general partner
is GCOP Associates Limited Partnership, a Massachusetts limited partnership.
Subject to the Managing General Partner's overall authority, the business of the
Partnership is managed by AEW pursuant to an advisory contract.

         On December 10, 1996, Copley's parent, New England Investment
Companies, Limited Partnership ("NEIC"), a publicly traded master limited
partnership, acquired certain assets subject to then existing liabilities from
Aldrich, Eastman & Waltch, Inc. and its affiliates and principals (collectively,
"the AEW Operations"). Simultaneously, a new entity, AEW Capital Management L.P.
was formed, into which NEIC contributed its interests in Copley and its
affiliates. As a result, the AEW Operations were combined with Copley to form
the business operations of AEW Capital Management, L.P. At year end 1997, NEIC
completed a restructuring plan under which it contributed all of its operations
to a newly formed private partnership, NEIC Operating Partnership, L.P., in
exchange for a general partnership interest in the newly formed entity. As such,
at December 31, 1997, AEW Capital Management, L.P. is wholly owned by NEIC
Operating Partnership, L.P. AEW is a subsidiary of AEW Capital Management, L.P.

         Prior to August 30, 1996, New England Mutual Life Insurance Company
("The New England") was NEIC's principal unit holder and owner of all the
outstanding stock of NEIC's general partner. On August 30, 1996, The New England
merged with and into Metropolitan Life Insurance Company ("Met Life"). Met Life
is the surviving entity and, therefore, through a wholly-owned subsidiary,
became the owner of the units of partnership interest previously owned by The
New England and of the stock of NEIC's general partner.

Management

         AEW, as advisor, is entitled to receive stipulated fees from the
Partnership in consideration of services performed in connection with the
management of the Partnership and acquisition and disposition of Partnership
investments in real property. Partnership management fees are 9% of
distributable cash flow from operations, as defined, before deducting such fees.
AEW is also reimbursed for expenses incurred in connection with administering
the Partnership ($12,000 in 1997, $12,000 in 1996, and $11,646 in 1995).
Acquisition fees were based on 3% of the gross proceeds from the offering and
paid at the time commitments were initially funded. Disposition fees are limited
to the lesser of 3% of the selling price of the property, or 50% of the standard
real estate commission customarily charged by an independent real estate broker.
Payments of disposition fees are subject to the prior receipt by the limited
partners of their capital contributions plus a stipulated return thereon.
<PAGE>
 
         New England Securities Corporation, an indirect subsidiary of Met Life,
is engaged by the Partnership to act as its unit holder servicing agent. Fees
and out-of-pocket expenses for such services totaled $2,834, $2,702 and $2,437
in 1997, 1996 and 1995, respectively. Fees to Back Bay Advisors, L.P., a wholly-
owned subsidiary of NEIC, for short-term investment advisory services totaled
$1,726, $1,808 and $1,795 in 1997, 1996 and 1995, respectively.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

         The preparation of financial statements in conformity with generally
accepted accounting principles requires the Managing General Partner to make
estimates affecting the reported amounts of assets and liabilities, and of
revenues and expenses. In the Partnership's business, certain estimates require
an assessment of factors not within management's control, such as the ability of
tenants to perform under long-term leases and the ability of the properties to
sustain their occupancies in changing markets. Actual results, therefore, could
differ from those estimates.

Real Estate Joint Ventures

         Investments in joint ventures, including loans made to joint ventures
which are in substance real estate investments, are stated at cost, plus (minus)
equity in undistributed joint venture income (losses). Allocations of joint
venture income (losses) were made to the Partnership's venture partners as long
as they had substantial economic equity in the project. Currently, the
Partnership records an amount equal to 100% of the operating results of the
property, after the elimination of all inter-entity transactions, except for the
venture which includes an affiliate of the Partnership, which has substantial
economic equity in the project. Joint ventures are consolidated with the
accounts of the Partnership if, and when, the venture partner no longer shares
in the control of the business.

Property

         Property includes land and buildings and improvements, which are stated
at cost less accumulated depreciation, plus other operating assets and
liabilities. The Partnership's initial carrying value of a property previously
owned by a joint venture equals the Partnership's carrying value of the
predecessor investment on the conversion date.

Capitalized Costs, Depreciation and Amortization

         Maintenance and repair costs are expensed as incurred; significant
improvements and renewals are capitalized. Depreciation is computed using the
straight-line method based on the estimated useful lives of the buildings and
improvements.

         Acquisition fees have been capitalized as part of the cost of real
estate investments. Amounts not related to land are being amortized using the
straight-line method over the estimated useful lives of the underlying real
property.

         Leases


         Leases are accounted for as operating leases. Leasing commissions are
amortized over the terms of the respective leases. Rental income is recognized
on a straight-line basis over the terms of the respective leases.
<PAGE>
 
Realizability of Real Estate Investments

         The Partnership considers a real estate investment to be impaired when
it determines the carrying value of the investment is not recoverable through
expected undiscounted cash flows from the operations and disposition of the
property. The impairment loss is based on the excess of the investment's
carrying value over its estimated fair market value. For investments being held
for disposition, the impairment loss also includes estimated costs of sale.
Investments held for disposition are not depreciated during the holding period.

         The carrying value of an investment may be more or less than its
current appraised value. At December 31, 1997 and 1996, the appraised value of
each investment exceeded its carrying value; the aggregate excess was
approximately $2,400,000 and $1,700,000, respectively.

         The current appraised value of real estate investments has been
estimated by the Managing General Partner and is generally based on a
combination of traditional appraisal approaches performed by AEW and independent
appraisers. Because of the subjectivity inherent in the valuation process, the
current appraised value may differ significantly from that which could be
realized if the real estate were actually offered for sale in the marketplace.

Cash Equivalents and Short-Term Investments

         Cash equivalents are stated at cost, plus accrued interest. The
Partnership considers all highly liquid debt instruments purchased with a
maturity of ninety days or less to be cash equivalents; otherwise, they are
classified as short-term investments.

         The Partnership has the positive intent and ability to hold all short-
term investments to maturity; therefore, short-term investments are carried at
cost plus accrued interest, which approximates market value. At December 31,
1997 and 1996, all investments are in commercial paper with less than two months
and one month, respectively, remaining to maturity.

Income Taxes

         A partnership is not liable for income taxes and, therefore, no
provision for income taxes is made in the financial statements of the
Partnership. A proportionate share of the Partnership's income is reportable on
each partner's tax return.

Per Unit Computations

         Per unit computations are based on the number of units of limited
partnership interest outstanding during the year. The actual per unit amount
will vary by partner depending on the date of admission to, or withdrawal from,
the Partnership.

         Effective January 1, 1998, the Partnership adopted FAS 128 "Earnings
per Share," which simplifies the standards of reporting earnings per share (EPS)
previously found in APB No. 15. It provides guidance on the computation and
disclosure of basic and diluted EPS and requires restatement of prior periods
for comparative purposes. The adoption of FAS 128 did not have a material impact
on the Partnership's financial statements.
<PAGE>
 
NOTE 3 - REAL ESTATE JOINT VENTURES

         The Partnership had invested in two real estate joint ventures
organized as general partnerships with a real estate management/development firm
and, in one case, with an affiliate of the Partnership. The ownership of both
ventures was restructured in 1996, as described below. The Partnership made
capital contributions to the ventures, which are subject to preferential cash
distributions at a specified rate and to priority distributions with respect to
sale or refinancing proceeds. The Partnership also made a mortgage loan to one
of the ventures. The joint venture agreements provide for the funding of cash
flow deficits by the venture partners in proportion to ownership interests, and
for the dilution of ownership share in the event a venture partner does not
contribute proportionately.

         The respective real estate management/development firm is responsible
for day-to-day development and operating activities, although overall authority
and responsibility for the business is shared by the venturers. The real estate
management/development firms, or their affiliates, also provide various services
to the joint ventures for a fee.

                  The following is a summary of cash invested in joint ventures,
net of returns of capital and excluding investment acquisition fees:

<TABLE> 
<CAPTION> 
                                                                                           December 31,
                                       Rate of                 Ownership         -------------------------------
Investment/Location                 Return/Interest             Interest            1997                1996
-------------------                 ---------------           ----------         ------------       ------------  
<S>                                 <C>                       <C>                <C>                <C> 
Shasta Way
 Simi Valley, CA                       10.0% (C)                   58%            $ 6,726,051        $ 6,726,051
</TABLE> 

(C) Capital contribution



Shasta Way

         On September 29, 1989, the Partnership entered into a joint venture
with an affiliate of the Partnership, and with an affiliate of The Hewson
Company, to construct and operate an industrial facility in Simi Valley,
California. The Partnership committed to make capital contributions of up to
$7,612,500, of which $7,111,757 was funded at December 31, 1997 and 1996. The
venture owns land on which it completed construction of an industrial building
in 1991. Effective January 1, 1996, the joint venture was restructured, and the
Hewson Company interest was assigned to the Partnership and its affiliate in
proportion to their respective ownership interests. The Partnership's ownership
percentage increased from 34.8% to 58%; its affiliate's interest was increased
to 42%.

         The aggregate minimum rents due to the venture under a non-cancelable
lease are: 1998 - $1,188,000.

South Bay Associates

         Effective January 1, 1996, this joint venture was restructured and the
joint venture partner's ownership interest was assigned to the Partnership. The
investment was accounted for as a wholly-owned property through the date of sale
on July 27, 1997. (See Note 4).
<PAGE>
 
Summarized Financial Information

The following summarized financial information is presented in the aggregate for
the joint ventures:


                                                                 
<TABLE> 
<CAPTION> 
                                           Assets and Liabilities 

                                                                                   December 31,
                                                                ---------------------------------------------------
                                                                       1997                            1996
                                                                --------------------           --------------------
<S>                                                             <C>                            <C> 
Assets
 Real property, at cost less
  accumulated depreciation
  of $2,132,388 and $1,709,771                                  $          7,565,996           $          7,988,613
 Other                                                                       165,813                        515,758
                                                                --------------------           --------------------
                                                                           7,731,809                      8,504,371

Liabilities                                                                   81,052                         74,585
                                                                --------------------           --------------------

   Net assets                                                   $          7,650,757           $          8,429,786
                                                                ====================           ====================


                                           Results of Operations

                                                                         Year ended December 31,
                                                    ------------------------------------------------------------------
                                                        1997                       1996                     1995
                                                    ---------------          -----------------         ---------------
<S>                                                 <C>                      <C>                       <C> 
Revenue
 Rental income                                      $     1,205,152          $       1,208,205         $     1,696,790
 Other                                                        5,914                      3,636                   4,934
                                                    ---------------          -----------------         ---------------
                                                          1,211,066                  1,211,841               1,701,724
                                                    ---------------          -----------------         ---------------

Expenses
  Depreciation and amortization                             460,785                    460,785                 529,694
  Operating expenses                                        196,910                    183,211                 314,583
                                                    ---------------          -----------------         ---------------
                                                            657,695                    643,996                 844,277
                                                    ---------------          -----------------         ---------------

Net income                                          $       553,371          $         567,845         $       857,447
                                                    ===============          =================         ===============
</TABLE> 

         Liabilities and expenses exclude amounts owed and attributable to the
Partnership and (with respect to one joint venture) its affiliate on behalf of
their various financing arrangements with the joint ventures.

         Amounts for 1997 and 1996 relate only to the Shasta Way joint venture.
<PAGE>
 
NOTE 4 - INVESTMENT IN PROPERTY

The following is a summary of the Partnership's investment in property:

<TABLE> 
<CAPTION> 

                                                                           December 31,
                                                       -------------------------------------------------------
                                                             1997                                  1996
                                                       ------------------                   ------------------
<S>                                                    <C>                                  <C> 
      Land                                             $        2,991,854                   $        5,771,144
      Buildings and improvements                                5,978,755                            9,601,263
      Accumulated depreciation                                 (1,960,425)                          (1,758,213)
      Investment valuation allowance                                    -                           (2,400,000)
      Deferred costs, net                                         375,329                              445,638
      Other net assets (liabilities)                              (70,587)                             129,395
                                                       ------------------                   ------------------
         Net carrying value                            $        7,314,926                   $       11,789,227
                                                       ==================                   ==================
</TABLE> 

         The net carrying value at December 31, 1997 is comprised solely of the
Brea West property. The net carrying value at December 31, 1996 was comprised of
Brea West and South Bay at $7,561,745 and $4,227,482, respectively.

         South Bay Associates

         On May 18, 1989, the Partnership entered into a joint venture with an
affiliate of South Bay Construction and Development Co. Inc., to acquire and
operate a research and development facility in San Jose, California. The
Partnership invested $7,028,247 in the joint venture in the form of capital
contributions and a mortgage loan. Effective January 1, 1996, the joint venture
was restructured and the joint venture partner's ownership interest was assigned
to the Partnership. The carrying value of the joint venture investment at
conversion ($4,180,704) was allocated to land, building and improvements, an
investment valuation allowance, and other net operating assets.

         On July 22, 1997, the South Bay property was sold to the sole tenant
which exercised the purchase option under its lease for gross consideration of
$5,850,000. The Partnership received net proceeds of $5,715,415, after closing
costs, and recognized a gain of $1,490,313 ($53.38 per limited partnership unit)
on the sale. A disposition fee of $29,250 was accrued but not paid to AEW. On
July 24, 1997, the Partnership made a capital distribution of $5,528,200 ($200
per limited partnership unit) from the proceeds of the sale.

         Brea West

         On April 28, 1989, the Partnership entered into a joint venture
agreement to construct and operate an industrial facility in Brea, California.
The Partnership contributed $9,078,799 to the capital of the venture. The
venture partner was unable to fund its proportionate share of the cost overruns
and, effective June 30, 1991, the venture partner's ownership share was reduced
to zero and the property became wholly-owned by the Partnership.

         The building is being depreciated over 30 years. Tenant improvements
are being depreciated over the original lease term. Minimum annual future rent
payments are as follows: 1998 - $914,958; 1999 - $914,958; 2000 - $944,964; 
2001 - $890,100; 2002 - $912,352; thereafter - $4,644,728.
<PAGE>
 
NOTE 5 - INCOME TAXES

         The Partnership's income for federal income tax purposes differs from
that reported in the accompanying statement of operations as follows:

<TABLE> 
<CAPTION> 
                                                                           Year ended December 31,
                                                        --------------------------------------------------------------
                                                              1997                  1996                   1995
                                                        ----------------      -----------------       ----------------
<S>                                                     <C>                   <C>                     <C> 
Net income per financial
 statements                                             $     2,303,492       $       1,058,287       $      1,025,324

Timing differences:
  Joint venture earnings (losses)                               (85,995)                167,259                156,936
  Rental revenue                                                 79,451                  24,517                 19,318
  Expenses                                                       11,090                   7,096                 10,456
  Depreciation                                                   79,040                  73,015                 76,416
  Loss on sale                                               (2,008,862)                      -                      -
                                                        ----------------      -----------------       ----------------

Taxable income                                          $       378,216       $       1,330,174       $      1,288,450
                                                        ===============       =================       ================
</TABLE> 

NOTE 6 - PARTNERS' CAPITAL

         Allocation of net income (losses) from operations and distributions of
distributable cash from operations, as defined, are in the ratio of 99% to the
limited partners and 1% to the general partners. Cash distributions are made
quarterly .

         Net sales proceeds and financing proceeds will be allocated first to
limited partners to the extent of their contributed capital plus a stipulated
return thereon, as defined, second to pay disposition fees, and then 85% to the
limited partners and 15% to the general partners. Income from sales will be
allocated in proportion to the distribution of related proceeds, provided that
the general partners are allocated at least 1%. Income or losses from sales, if
there are no residual proceeds after the repayment of the related debt, will be
allocated 99% to the limited partners and 1% to the general partners.

NOTE 7 - SUBSEQUENT EVENT

         Distributions of cash from operations relating to the quarter ended
December 31, 1997 were made on January 29, 1998 in the aggregate amount of
$390,883 ($14.00 per limited partnership unit).
<PAGE>
 
                        COPLEY REALTY INCOME PARTNERS 3;
                              A LIMITED PARTNERSHIP
                                  SCHEDULE III

                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                                DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                                           Initial Cost to                    Costs Capitalized          
                                                           the Partnership                Subsequent to Acquisition      
                                                  ------------------------------------  ----------------------------------
                                     Encum-                     Buildings &    Other       Carrying    Improve-                 
  Description                       brances           Land      Improvements   (Net)         Costs      ments       Other  
----------------                   ------------   ----------- -------------- ---------  ------------ ---------- ----------
<S>                                <C>            <C>         <C>            <C>        <C>          <C>        <C> 
A single-story industrial  
building on 7.51 acres in          Notes A & B     $2,917,098   $5,974,055   $(81,193)     $74,756    $  4,700   $ 353,790
Brea, California           
                           
A single-story industrial           Notes B
building on 6.7 acres                and C         $1,699,290   $2,115,672   $365,742           $0    $186,836   $(259,815)
in San Jose, California    
                                                   ----------   ----------   --------      -------    --------   ---------
    Total Wholly-Owned                             $4,616,388   $8,089,727   $284,549      $74,756    $191,536   $  93,975
                                                  ===========   ==========   ========      =======    ========   =========

58% Interest in Hewson Shasta   
Way Joint Venture. Owner of    
an industrial building on 12.13   --------------------------------------------------------See Note C------------------------
acres in Simi Valley, California 
</TABLE> 

<TABLE>
<CAPTION>

                                            Gross amount at which
                                        Carried at Close of Period
                                    --------------------------------------
                                                    Buildings &                            Accumulated                  Date of    
  Description                             Land      Improvements    Other      Total      Depreciation     Sales      Construction 
----------------                    -------------- -------------- -------- ------------ ---------------- ---------  ---------------
<S>                                 <C>            <C>            <C>      <C>         <C>              <C>        <C> 
A single-story industrial      
building on 7.51 acres in             $2,991,854     $5,978,755   $304,742  $ 9,275,351    $1,960,425   $         0       1990
Brea, California               
                               
A single-story industrial      
building on 6.7 acres                 $1,699,290     $2,302,508   $105,927  $ 4,107,725    $  118,242   $(3,989,483)      1976
in San Jose, California               
                                      ----------     ----------   --------  -----------    ----------   -----------    
    Total Wholly-Owned                $4,691,144     $8,281,263   $410,669  $13,383,076    $2,078,667   $(3,989,483)
                                      ==========     ==========   ========  ===========    ==========   ============

58% Interest in Hewson Shasta   
Way Joint Venture. Owner of    
an industrial building on 12.13    ---------------------------------------  $ 5,071,717           N/A   $         0       1991
acres in Simi Valley, California                                            -----------                 -----------
         Total Joint Ventures                                               $ 5,071,717                 $         0
                                                                            ===========                 ===========
</TABLE> 

<TABLE> 
<CAPTION> 

                                           Date          Date       Depreciable
  Description                            Acquired        Sold          Life
----------------                       ------------- ----------- ---------------
<S>                                    <C>           <C>         <C>                 
A single-story industrial       
building on 7.51 acres in                06/30/91                     30 Years       
Brea, California                                                                     
                                                                                     
A single-story industrial       
building on 6.7 acres                    05/18/89      07/22/97       30 Years       
in San Jose, California                                                              
                               
    Total Wholly-Owned         


58% Interest in Hewson Shasta    
Way Joint Venture. Owner of     
an industrial building on 12.13           09/29/89                   31.5 Years
acres in Simi Valley, California 

</TABLE> 

Note (A) South Bay/CRIP 3 investment restructured from joint venture to 
wholly-owned property effective 1/1/96.

<PAGE>
  
                       COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP

                             SCHEDULE III - NOTE B
                   REAL ESTATE AND ACCUMULATED DEPRECIATION
                        DECEMBER 31, 1995, 1996 & 1997


<TABLE> 
<CAPTION> 
Reconciliation of Real                                                        1995
   Estate Owned                                   1995          1995       INVESTMENT
                               BALANCE        CAPITALIZED       OTHER       VALUATION       BALANCE
      DESCRIPTION            AT 12/31/94     IMPROVEMENTS    NET ASSETS     ALLOWANCE     AT 12/31/95
------------------------    --------------   --------------  ------------  -----------  --------------
<S>                         <C>              <C>             <C>           <C>          <C> 
       Brea West             $ 9,555,442        $      0       $ (19,149)       $0         $ 9,536,293
                             -----------        --------       ---------        --         -----------
                             $ 9,555,442        $      0       $ (19,149)       $0         $ 9,536,293
                             ===========        ========       =========        ==         ===========


                                                                              1996
                                                  1996          1996       INVESTMENT
                               BALANCE        CAPITALIZED       OTHER       VALUATION       BALANCE
                             AT 12/31/95     IMPROVEMENTS    NET ASSETS     ALLOWANCE     AT 12/31/96
                            --------------   --------------  ------------  -----------  --------------
       Brea West             $ 9,536,293        $      0       $ (26,221)       $0         $ 9,510,072
   South Bay/CRIP 3            4,180,704(A)      186,836         (40,904)        0           4,326,636
                             -----------        --------       ---------        --         -----------
                             $13,716,997        $186,636       $ (67,125)       $0         $13,836,708
                             ===========        ========       =========        ==         ===========


                                                                              1997
                                                  1997          1997       INVESTMENT
                               BALANCE        CAPITALIZED       OTHER       VALUATION       BALANCE
                             AT 12/31/96     IMPROVEMENTS    NET ASSETS     ALLOWANCE     AT 12/31/97
                            --------------   --------------  ------------  -----------  --------------
       Brea West             $ 9,510,072        $      0       $  86,768        $0         $ 9,596,840
   South Bay/CRIP 3            4,326,636               0        (196,509)        0           4,130,127
                             -----------        --------       ---------        --         -----------
                             $13,836,708        $      0       $(109,741)       $0         $13,726,967
                             ===========        ========       =========        ==         ===========

</TABLE> 


<TABLE> 
<CAPTION> 
Reconciliation of Real        ACCUMULATED                       ACCUMULATED                               
   Estate Owned               DEPRECIATION         1995         DEPRECIATION                              
                             & AMORTIZATION    DEPRECIATION   & AMORTIZATION                             
                                BALANCE       & AMORTIZATION      BALANCE          1995       BALANCE (NET)
      DESCRIPTION             AT 12/31/94        EXPENSE        AT 12/31/95        SALES       AT 12/31/95
------------------------    --------------   --------------  -----------------  -----------  --------------
<S>                         <C>              <C>             <C>                <C>          <C>          
       Brea West             $ 1,304,001        $322,163       $1,626,164       $       0      $ 7,910,129
                             -----------        --------       ----------       ---------      -----------
                             $ 1,304,001        $322,163       $1,626,164       $       0      $ 7,910,129
                             ===========        ========       ==========       =========      =========== 


                              ACCUMULATED                       ACCUMULATED                               
                              DEPRECIATION         1996         DEPRECIATION                              
                             & AMORTIZATION    DEPRECIATION   & AMORTIZATION                             
                                BALANCE       & AMORTIZATION      BALANCE          1996       BALANCE (NET)
                              AT 12/31/95        EXPENSE        AT 12/31/96        SALES       AT 12/31/96
                            --------------   --------------  -----------------  -----------  --------------
       Brea West             $ 1,626,164        $322,163        $1,948,327      $        0      $ 7,561,745
   South Bay/CRIP 3                    0          99,154            99,154               0        4,227,482
                             -----------        --------        ----------      ----------      -----------
                             $ 1,626,164        $421,317        $2,047,481      $        0      $11,789,227
                             ===========        ========        ==========      ==========      =========== 


                              ACCUMULATED                       ACCUMULATED                               
                              DEPRECIATION         1997         DEPRECIATION                              
                             & AMORTIZATION    DEPRECIATION   & AMORTIZATION                             
                                BALANCE       & AMORTIZATION      BALANCE           1997       BALANCE (NET)
                              AT 12/31/96        EXPENSE        AT 12/31/97         SALES       AT 12/31/97
                            --------------   --------------  -----------------  ------------  --------------
       Brea West             $ 1,948,327        $333,587        $2,281,914      $         0    $ 7,314,926
   South Bay/CRIP 3               99,154          52,691           151,845       (3,978,282)             0
                             -----------        --------        ----------      -----------    -----------
                             $ 2,047,481        $386,278        $2,433,759      $(3,978,282)   $ 7,314,926
                             ===========        ========        ==========      ===========    =========== 

            (A) Carrying value at conversion date (1/1/96)

</TABLE> 



<PAGE>
 
                       COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP

                             SCHEDULE III - NOTE C
                   REAL ESTATE AND ACCUMULATED DEPRECIATION
                        DECEMBER 31, 1995, 1996 & 1997


<TABLE> 
<CAPTION> 
                                                                                                            1995
                                                                1995                   1995            AMORTIZATION OF
                             PERCENT OF         BALANCE      CASH INVESTMENT         EQUITY IN          ACQUISITION 
      DESCRIPTION            OWNERSHIP        AT 12/31/94    IN JOINT VENTURE      INCOME (LOSS)           FEES     
------------------------    --------------   ------------    ----------------     --------------     ----------------- 
<S>                         <C>              <C>             <C>                  <C>                <C>            
  South Bay / CRIP 3           71.07%        $  4,173,588    $         68,687     $      315,789     $          (3,360) 

Shasta Way Associates          34.8%            6,120,287                   0            312,772                (7,096)
                                             ------------    ----------------     --------------     ----------------- 
                                             $ 10,293,875    $         68,687     $      628,561     $         (10,456)
                                             ============    ================     ==============     ================= 

                            
                             1995 CASH           1995           CONVERSION
                            DISTRIBUTIONS     INVESTMENT           TO
                                FROM          VALUATION        WHOLLY-OWNED         BALANCE
                            JOINT VENTURE     ALLOWANCE          PROPERTY         AT 12/31/95
                            --------------   ------------    ----------------     -----------    
                            $     (374,000)  $          0    $              0     $ 4,180,704

                                  (565,499)             0                   0       5,860,464
                            --------------   ------------    ----------------     -----------    
                            $     (939,499)  $          0    $              0     $10,041,168
                            ==============   ============    ================     ===========    


                                                                                                            1996
                                                                1996                   1996            AMORTIZATION OF
                             PERCENT OF         BALANCE      CASH INVESTMENT         EQUITY IN          ACQUISITION 
      DESCRIPTION            OWNERSHIP        AT 12/31/95    IN JOINT VENTURE      INCOME (LOSS)           FEES     
------------------------    --------------   ------------    ----------------     --------------     -----------------  
  South Bay / CRIP 3           100%          $  4,180,704    $              0     $            0     $               0

Shasta Way Associates           58%             5,860,464                   0            328,348                (7,096)
                                             ------------    ----------------     --------------     -----------------  
                                             $ 10,041,168    $              0     $      328,348     $          (7,096)
                                             ============    ================     ==============     =================  


                             1996 CASH           1996           CONVERSION
                            DISTRIBUTIONS     INVESTMENT           TO
                                FROM          VALUATION        WHOLLY-OWNED         BALANCE
                            JOINT VENTURE     ALLOWANCE          PROPERTY         AT 12/31/96
                            --------------   ------------    ----------------     -----------    
                            $            0   $          0    $     (4,180,704)(A) $         0

                                  (650,064)             0                   0       5,531,652
                            --------------   ------------    ----------------     -----------    
                            $     (650,064)  $          0    $     (4,180,704)    $ 5,531,652
                            ==============   ============    ================     ===========    


                                                                                                            1997
                                                                1997                   1997            AMORTIZATION OF
                             PERCENT OF         BALANCE      CASH INVESTMENT         EQUITY IN          ACQUISITION 
      DESCRIPTION            OWNERSHIP        AT 12/31/96    IN JOINT VENTURE      INCOME (LOSS)           FEES     
------------------------    --------------   ------------    ----------------     --------------     -----------------  
Shasta Way Associates           58%          $  5,531,662    $              0     $      319,953     $          (7,096)
                                             ------------    ----------------     --------------     -----------------  
                                             $  5,531,662    $              0     $      319,953     $          (7,096)
                                             ============    ================     ==============     ================= 
 

                             1997 CASH           1997           CONVERSION
                            DISTRIBUTIONS     INVESTMENT           TO
                                FROM          VALUATION        WHOLLY-OWNED            1997               BALANCE  
                            JOINT VENTURE     ALLOWANCE          PROPERTY             SALES             AT 12/31/97
                            --------------   ------------    ----------------      -----------          -----------  
                            $     (772,792)  $          0    $              0      $         0          $ 5,071,717
                            --------------   ------------    ----------------      -----------          -----------  
                            $     (772,792)  $          0    $              0      $         0          $ 5,071,717
                            ==============   ============    ================      ===========          ===========  

</TABLE> 


<PAGE>
 
                              FINANCIAL STATEMENTS
                                   INDEX NO. 2

              Independent Auditor's Report and Financial Statements

                            of Shasta Way Associates








                  Report of Independent Auditors from Ernst & Young LLP

                  Balance Sheets - December 31, 1997 and 1996

                  Statements of Operations - For the Years ended
                    December 31, 1997, 1996 and 1995

                  Statements  of  Changes in  Partners'  Capital - For the Years
                    ended December 31, 1997, 1996 and 1995

                  Statements  of Cash Flows - For the Years ended  December  31,
                    1997, 1996 and 1995

                  Notes to Financial Statements
<PAGE>
 
                                             FINANCIAL STATEMENTS        
                                                                         
                                             SHASTA WAY ASSOCIATES       
                                      (A CALIFORNIA GENERAL PARTNERSHIP) 
                                                                         
                                          December 31, 1997 and 1996      
<PAGE>
 
                              Shasta Way Associates
                       (A California General Partnership)

                              Financial Statements

                           December 31, 1997 and 1996






                                    Contents

Report of Independent Auditors...............................................1
                                                      
Financial Statements                                  
                                                      
Balance Sheets...............................................................2
Statements of Operations.....................................................3
Statements of Partners' Capital..............................................4
Statements of Cash Flows.....................................................5
Notes to Financial Statements................................................6
<PAGE>
 
                    [ERNST & YOUNG LETTERHEAD Appears Here]


                         Report of Independent Auditors


To the Partners
Shasta Way Associates

We have audited the  accompanying  balance  sheets of Shasta Way  Associates  (a
California  general  partnership)  as of  December  31,  1997 and 1996,  and the
related statements of operations,  partners' capital, and cash flows for each of
the  three  years  in the  period  ended  December  31,  1997.  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 Shasta Way  Associates  at
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended  December 31, 1997 in conformity
with generally accepted accounting principles.




                                                   Ernst & Young LLP

Phoenix, Arizona
January 20, 1998


                                                                               1
<PAGE>
 
                              Shasta Way Associates
                       (A California General Partnership)

                                 Balance Sheets

<TABLE> 
<CAPTION> 
                                                                                         DECEMBER 31,
                                                                             -------------------------------------
                                                                                   1997               1996
                                                                             ------------------ ------------------
<S>                                                                           <C>                <C> 
ASSETS
Cash                                                                           $       8,718      $     166,413
Tenant receivables                                                                   116,212            270,294
Rental property
  Land                                                                             2,977,867          2,977,867
  Buildings                                                                        6,803,913          6,803,913
  Accumulated depreciation                                                        (2,146,952)        (1,721,687)
                                                                             ------------------ ------------------
                                                                                   7,634,828          8,060,093
                                                                             ------------------ ------------------
Other assets - net of accumulated amortization of $181,717 in 1997 and
   $315,164 in 1996                                                                   40,883             79,051
                                                                             ================== ==================
                                                                               $   7,800,641      $   8,575,851
                                                                             ================== ==================

Liabilities and partners' capital
Security deposit                                                               $      62,400      $      62,400
Accounts payable and accrued expenses                                                 18,652             12,185
Due to partners
  CRIP 3                                                                           1,802,692          1,694,054
  CRIP 4                                                                           1,305,250          1,226,586
Partners' capital                                                                  4,611,647          5,580,626
                                                                             ------------------ ------------------
                                                                               $   7,800,641      $   8,575,851
                                                                             ================== ==================

</TABLE> 





See accompanying notes.                                                        2
<PAGE>
 
                             Shasta Way Associates
                      (A California General Partnership)

                            Statements of Operations

<TABLE> 
<CAPTION> 
                                                                          Year ended December 31,
                                                         ---------------------------------------------------------
                                                                1997               1996               1995
                                                         ------------------- ------------------ ------------------
<S>                                                      <C>                 <C>                 <C> 
Revenues
  Rental income                                               $1,045,432          $1,045,432         $1,012,427 
  Tenant reimbursements                                          159,720             162,773            151,424
  Interest and other income                                        5,914               3,636              3,992
                                                         ------------------- ------------------ ------------------
                                                               1,211,066           1,211,841          1,167,843
                                                         ------------------- ------------------ ------------------

Expenses
  Rental operating expenses                                      184,831             160,800            155,744
  General and administrative                                      12,079              22,411             11,272
  Depreciation and amortization                                  463,433             463,433            462,485
  Guaranteed payments
    CRIP 3                                                       881,430             868,326            844,281
    CRIP 4                                                       638,272             628,733            611,374
                                                         ------------------- ------------------ ------------------
                                                               2,180,045           2,143,703          2,085,156
                                                         ------------------- ------------------ ------------------

Net loss                                                      $ (968,979)         $ (931,862)        $ (917,313) 
                                                         =================== ================== ==================
</TABLE> 




See accompanying notes.                                                        3
<PAGE>
 
                             Shasta Way Associates
                      (A California General Partnership)

                         Statements of Partners' Capital

<TABLE> 
<CAPTION> 
                                                                   Copley            Copley
                                                 Hewson            Realty            Realty
                                               Shasta Way          Income            Income
                                                  L.P.           Partners 3        Partners 4          Total
                                             ---------------- ----------------- ----------------- ----------------
<S>                                          <C>              <C>               <C>                <C> 
Partners' capital - (deficit)
  December 31, 1994                            $    (604,984)   $   4,660,174     $   3,374,611     $   7,429,801
Net loss - 1995                                            -         (532,041)         (385,272)         (917,313)
                                             ---------------- ----------------- ----------------- ----------------
Partners' capital - (deficit)
  December 31, 1995                                 (604,984)       4,128,133         2,989,339         6,512,488
Transfer of interest                                 604,984         (350,891)         (254,093)                -
Net loss - 1996                                            -         (540,480)         (391,382)         (931,862)
                                             ---------------- ----------------- ----------------- ----------------
Partners' capital -
  December 31, 1996                                        -        3,236,762         2,343,864         5,580,626
Net loss - 1997                                            -         (562,008)         (406,971)         (968,979)
                                             ================ ================= ================= ================
Partners' capital -
  December 31, 1997                            $           -    $   2,674,754     $   1,936,893     $   4,611,647
                                             ================ ================= ================= ================
</TABLE> 





See accompanying notes.                                                        4
<PAGE>
 
                             Shasta Way Associates
                      (A California General Partnership)

                            Statements of Cash Flows
<TABLE> 
<CAPTION> 
                                                                          Year ended December 31
                                                         ---------------------------------------------------------
                                                                1997               1996               1995
                                                         ------------------- ------------------ ------------------
<S>                                                       <C>                <C>                 <C> 
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss                                                  $      (968,979)    $      (931,862)   $      (917,313)
  Adjustments to reconcile net loss to net
    cash provided by operating activities
      Depreciation and amortization                               463,433             463,433            462,485
      Decrease (increase) in tenant receivables                   154,082             151,238             74,093
      Increase (decrease) in accounts payable and
        accrued expenses                                            6,467               4,014               (672)
      Increase in due to partners                                 187,302             376,259            480,655
                                                         ------------------- ------------------ ------------------
Total adjustments                                                 811,284             994,944          1,016,561
                                                         ------------------- ------------------ ------------------
Net cash (used in) provided by investing
  activities                                                     (157,695)             63,082             99,248
                                                         ------------------- ------------------ ------------------

CASH FLOWS FROM INVESTING ACTIVITIES
Additions to rental property                                            -                   -             (9,482)
                                                         ------------------- ------------------ ------------------

Net (decrease) increase in cash                                  (157,695)             63,082             89,766
Cash at beginning of year                                         166,413             103,331             13,565
                                                         ------------------- ------------------ ------------------
Cash at end of year                                       $         8,718     $       166,413    $       103,331
                                                         =================== ================== ==================
</TABLE> 






See accompanying notes.                                                        5
<PAGE>
 
                             Shasta Way Associates
                      (A California General Partnership)

                          Notes to Financial Statements

                           December 31, 1997 and 1996


1. ORGANIZATION AND OTHER MATTERS

Shasta Way Associates,  formerly Hewson Shasta Way Associates (the Partnership),
was formed  September  29,  1989 as a  California  general  partnership  for the
purpose of  developing  and operating a commercial  industrial  property in Simi
Valley, California. The percentage ownership interests through December 31, 1995
were as follows:

        Hewson Shasta Way L.P., a California limited     
         partnership (Hewson)                                   40.0%         
        Copley Realty Income Partners 3 (CRIP 3)                34.8%         
        Copley Realty Income Partners 4 (CRIP 4)                25.2%         

CRIP 3 and CRIP 4 were  committed to  contribute  an aggregate of  approximately
$13,125,000 to the Partnership; subsequently, the Partnership Agreement provides
for pro  rata  contributions  by all  partners.  CRIP 3 and  CRIP 4  contributed
$7,111,757 and $5,149,893, respectively, through December 31, 1997.

CRIP 3 and CRIP 4 are entitled to preferential  cash payments to the extent of a
stipulated  return  on their  invested  capital  (Note  4).  Prior to 1992,  for
financial reporting  purposes,  income and losses were allocated to the partners
in accordance with their respective ownership interests,  based on the long-term
substance of the business  enterprise  and the  requirement  for all partners to
fund  capital,  as described  above.  For the years ended  December 31, 1995 and
1994, losses were allocated entirely to CRIP 3 and CRIP 4.

On January 1, 1996, the partners executed an Amended and Restated Statement of
Partnership Agreement whereby Hewson transferred all of its right, title and
interest in and to the Partnership to CRIP 3 and CRIP 4. The percentage
ownership interests are as follows:

        Copley Realty Income Partners 3 (CRIP 3)                  58.0%
        Copley Realty Income Partners 4 (CRIP 4)                  42.0%

Beginning January 1, 1996, income and losses are allocated to CRIP 3 and CRIP 4
in accordance with the ownership interests.



                                                                               6
<PAGE>
 
                              Shasta Way Associates
                       (A California General Partnership)

                    Notes to Financial Statements (continued)


2. SIGNIFICANT ACCOUNTING POLICIES

RENTAL PROPERTY

Rental properties are stated at cost. In 1996, the Partnership adopted 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." SFAS No. 121
requires  that real estate  assets be evaluated  for  impairment  if  impairment
indicators are present.  An impairment  writedown to fair value would occur only
if the  estimated  undiscounted  cash  flows  from the asset  were less than the
carrying  amount of the asset.  At December 31, 1997, the  Partnership  does not
hold any assets that meet the impairment criteria of SFAS No. 121.

INCOME RECOGNITION

The  Partnership's  rental  property  is leased to a tenant  under an  operating
lease. The lease includes a provision  whereby the tenant is not responsible for
rental  payments for specified  occupancy  periods.  Rental income is recognized
over the lease term on a straight-line basis. Included in tenant receivables are
$98,760 and $197,519 of deferred rent  receivable at December 31, 1997 and 1996,
respectively.

INCOME TAXES

Federal and state  income  taxes are not payable by the  Partnership,  since the
partners  report their  proportionate  share of taxable  income or loss on their
separate tax returns.

DEPRECIATION AND AMORTIZATION

Depreciation is provided on the straight-line method over the estimated lives of
the assets,  which are 31.5 years for the  building and the term of the tenant's
lease for tenant improvements.

Included in other assets are leasing  commissions,  which are amortized over the
term of the related tenant's lease.

USE OF ESTIMATES

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial  statements and accompanying notes.
Actual results could differ from those estimates.


                                                                               7
<PAGE>
 
                              Shasta Way Associates
                       (A California General Partnership)

                    Notes to Financial Statements (continued)


3. RENTAL PROPERTY

At  December  31,  1989 the  rental  property  under  development  consisted  of
approximately  12 acres of land, with two existing  buildings.  During 1990, the
existing  buildings were demolished and  construction  of a 235,080  square-foot
industrial building commenced. Construction was completed in June 1991.

The Partnership's  property is being leased to a tenant under an operating lease
which expires in December  1998.  The lease provides for the tenant to reimburse
the Partnership for operating expenses.

Approximately $1,188,000 of minimum lease payments are due in 1998.

4. RELATED PARTY TRANSACTIONS

Under the terms of the Partnership  agreement,  as amended,  Hewson  Properties,
Inc.  (HPI),  an affiliate  of Hewson,  was paid a  development  overhead fee of
$272,428.  CRIP 3 and CRIP 4 were paid development  overhead fees of $48,370 and
$35,026,  respectively.  These fees were paid  beginning on the first day of the
month  following  the start of  demolition  of the existing  buildings  and were
capitalized to the rental property.

The  Partnership  agreement  provides  that  CRIP  3 and  CRIP 4  will  be  paid
guaranteed  payments of 10% per annum on  invested  capital  (as  defined).  The
cumulative  unpaid  guaranteed  payments  are included in due to partners in the
accompanying balance sheets.

Included  in rental  operating  expenses  are  $40,339,  $40,783  and $36,933 of
management fees paid to HPI in 1997, 1996 and 1995, respectively. These fees are
paid at a rate of 3% of gross rental income received.



                                                                               8
<PAGE>
 
                              Shasta Way Associates
                       (A California General Partnership)

                    Notes to Financial Statements (continued)


5. IMPACT OF YEAR 2000 (Unaudited)

Management of the Partnership is assessing the  modifications or replacements of
its software that may be necessary for its computer systems to function properly
with respect to the dates in the year 2000 and  thereafter.  Management does not
believe that the cost of either modifying existing software or converting to new
software will be significant  or that the year 2000 issue will pose  significant
operational problems for its computer systems.







                                                                               9
<PAGE>
 
                                  SIGNATURES


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

                                           COPLEY REALTY INCOME PARTNERS 3;
                                           A LIMITED PARTNERSHIP



Date:    March 27, 1998                    By:      /s/ Wesley M. Gardiner, Jr.
                                                    ---------------------------
                                                    Wesley M. Gardiner, Jr.
                                                    President of the
                                                    Managing General Partner


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

<TABLE> 
<CAPTION> 

         Signature                                 Title                                             Date
         ---------                                 -----                                             ----
<S>                                                <C>                                                <C> 
                                                                           
                                                                           
 /s/     Wesley M. Gardiner, Jr.                     President, Chief                            March 27, 1998
--------------------------------                     Executive Officer and 
         Wesley M. Gardiner, Jr.                     Director              


                                                                        
 /s/     Pamela J. Herbst                            Vice President and                          March 27, 1998
--------------------------------                     Director           
         Pamela J. Herbst

                                                                        
 /s/     J. Grant Monahon                            Vice President and                          March 27, 1998
--------------------------------                     Director           
         J. Grant Monahon


/s/      James J. Finnegan                           Vice President                              March 27, 1998
--------------------------------
         James J. Finnegan

                                                                              
/s/      Karin J. Lagerlund                          Treasurer and Principal  
--------------------------------                     Financial and Accounting                    March 27, 1998
         Karin J. Lagerlund                          Officer                  

</TABLE> 

<PAGE>
 
                                 EXHIBIT INDEX

Exhibit Number                                                       Page Number

10A.      Joint  Venture   Agreement  of  South  Bay/CRIP  3              *
          Associates  Joint  Venture dated as of March 27, 1989
          by and between  Copley  Realty  Income  Partners 3; A
          Limited Partnership and SBC and D Co., Inc.
         
10B.      General   Partnership   Agreement   of  Brea  West              *
          Associates  dated as of April  28,  1989  between  BW
          Partners  and  Copley  Realty  Income  Partners  3; A
          Limited Partnership.
         
10C.      First Amendment to Brea West Associates General                 *
          Partnership Agreement dated as of April 28, 1989
          by and between  Copley  Realty  Income  Partners 3; A
          Limited Partnership and BW Partners.
         
10D.      Pledge and Security Agreement for Brea West                     *
          Associates dated as of April 28, 1989 by and
          among BW Partners, Copley Realty Income Partners
          3; A Limited Partnership, and Tar Partners.
         
10E.      General Partnership  Agreement of Hewson Shasta Way             *
          Associates  dated as of  September  29, 1989  between
          Hewson/Shasta Way L.P., Copley Realty Income Partners
          3; A Limited Partnership and Copley Realty
          Income Partners 4; A Limited Partnership.
         
10F.      Purchase  Agreement  and  Escrow  Instruction  and              *
          Railroad Spur  Agreement  dated as of May 17, 1991 by
          and   between  NI   Industries,   Inc.,   a  Delaware
          corporation, and Brea West Associates
         
10G.      Agreement for Dissolution, Distribution and                     *
          Winding-Up of Brea West Associates dated
          May 31, 1991 by and between BW Partners, a
          California general partnership, and the
          Registrant
         
10H.      Incentive Property Management Agreement                         *
          effective as of May 31, 1991 by and between
          TRI-Partners, a California general partnership,
          and the Registrant
         
10I.      Lease  between  South  Bay/CRIP  3,  a  California              *
          general  partnership  ("Landlord"),  and  Media  Arts
          Group, Inc., a Delaware Corporation  ("Tenant)" dated
          February 7, 1994.
         
         
<PAGE>
 
10J.      First Amendment to Lease by and between                         *
          South Bay/CRIP 3, a California
          general partnership ("Landlord"), and Media Arts Group,
          Inc., a Delaware Corporation ("Tenant)" dated
          April 15, 1994.
         
10K.      Second Amendment to Lease by and between                        *
          South Bay/CRIP 3, a California
          general partnership ("Landlord"), and Media Arts Group,
          Inc., a Delaware Corporation ("Tenant)" dated
          June 23, 1994.
         
10L.      Promissory Note dated May 1, 1994 by and between                *
          South Bay/CRIP III Associates Joint Venture,
          a California general partnership, as Holder,
          and CXR Telcom Corporation, a Delaware
          Corporation, as Maker.
         
10M.      Assignment and Assumption and Indemnity Agreement dated         *
          January 1, 1996, by and between Hewson/Shasta Way L.P., a
          California limited partnership ("Assignor"), Copley Realty
          Income Partners 3; a Limited Partnership, a Massachusetts 
          limited partnership ("CRIP 3"), and Copley Realty Income 
          Partners 4; a Limited Partnership, a Massachusetts limited  
          partnership ("CRIP 4").
         
10N.      First Amendment to General Partnership Agreement dated          *
          January 1, 1996, as amended to date (the "Partnership
          Agreement") of Hewson Shasta Way Associates, a California
          general partnership, by and among Hewson/Shasta Way L.P.,
          a California limited partnership, Copley Realty Income
          Partners 3; a Limited Partnership, a Massachusetts limited
          partnership ("CRIP 3"), and Copley Realty Income Partners 4;
          a Limited Partnership, a Massachusetts limited partnership
          ("CRIP 4").
         
27.       Financial Data Schedule


--------------------------------------------
*  Previously filed and incorporated herein by reference