<PAGE>


                                                           1998
--------------------------------------------------------------------------------
Prudential-Bache/                                          Annual
Watson & Taylor, Ltd.-3                                    Report


<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                               1998 Annual Report
 
                                       1
 <PAGE>
<PAGE>
                         REPORT OF INDEPENDENT AUDITORS
 
To the Partners
Prudential-Bache/Watson & Taylor, Ltd.-3
 
We have audited the accompanying statements of net assets in process of
liquidation of Prudential-Bache/Watson & Taylor, Ltd.-3 as of September 30, 1998
and 1997, and the related statements of changes in net assets in process of
liquidation for the years then ended. In addition, we have audited the related
statements of operations, changes in partners' capital, and cash flows for the
year ended September 30, 1996. 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 net assets in process of liquidation of
Prudential-Bache/Watson & Taylor, Ltd.-3 as of September 30, 1998 and 1997, the
changes in its net assets in process of liquidation for the years then ended,
and the results of its operations and cash flows for the year ended September
30, 1996, in conformity with generally accepted accounting principles.
 
As discussed in Note B to the financial statements, the Partnership adopted the
liquidation basis of accounting effective October 1, 1996.
 
------------------------------------------------------------
/s/ Ernst & Young LLP
New York, New York
November 3, 1998
 
                                       2

<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                            STATEMENTS OF NET ASSETS
                          (in process of liquidation)
 
<TABLE>
<CAPTION>
                                                                         Year ended September 30,
                                                                         -------------------------
                                                                            1998           1997
<S>                                                                      <C>            <C>
--------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents                                                $  955,464     $1,089,835
Property held for sale                                                      275,000        275,000
                                                                         ----------     ----------
Total assets                                                              1,230,464      1,364,835
                                                                         ----------     ----------
LIABILITIES
Estimated liquidation costs                                                 162,712        220,331
                                                                         ----------     ----------
Net assets available to limited and general partners                     $1,067,752     $1,144,504
                                                                         ----------     ----------
                                                                         ----------     ----------
Limited and equivalent partnership units issued and outstanding              53,855         53,855
                                                                         ----------     ----------
                                                                         ----------     ----------
--------------------------------------------------------------------------------------------------
</TABLE>
 
                      STATEMENTS OF CHANGES IN NET ASSETS
                          (in process of liquidation)
                For the years ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
                                                             LIMITED       GENERAL
                                                            PARTNERS       PARTNERS        TOTAL
<S>                                                        <C>             <C>          <C>
---------------------------------------------------------------------------------------------------
Net assets in liquidation, October 1, 1996                 $10,428,257     $216,969     $10,645,226
Gain on sale of properties                                     327,104        3,304         330,408
Changes in estimated liquidation values of assets and
  liabilities                                                   34,443     (220,273)       (185,830)
Distributions                                               (9,645,300)          --      (9,645,300)
                                                           -----------     --------     -----------
Net assets in liquidation, September 30, 1997                1,144,504           --       1,144,504
Changes in estimated liquidation values of assets and
  liabilities                                                  (76,752)          --         (76,752)
                                                           -----------     --------     -----------
Net assets in liquidation, September 30, 1998              $ 1,067,752           --     $ 1,067,752
                                                           -----------     --------     -----------
                                                           -----------     --------     -----------
---------------------------------------------------------------------------------------------------
 
            The accompanying notes are an integral part of these statements.
</TABLE>
 
                                       3

<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                            STATEMENT OF OPERATIONS
                             (going concern basis)
                     For the year ended September 30, 1996
 
<TABLE>
<S>                                                                                    <C>
-------------------------------------------------------------------------------------------------
REVENUES
Rental income                                                                          $2,010,066
Interest                                                                                   28,000
Other                                                                                      14,824
                                                                                       ----------
                                                                                        2,052,890
                                                                                       ----------
EXPENSES
Property operating                                                                        711,167
Depreciation                                                                              136,271
Real estate taxes                                                                         225,336
General and administrative                                                                611,985
Interest                                                                                   29,497
                                                                                       ----------
                                                                                        1,714,256
                                                                                       ----------
Net income                                                                             $  338,634
                                                                                       ----------
                                                                                       ----------
ALLOCATION OF NET INCOME
Limited partners                                                                       $  302,004
                                                                                       ----------
                                                                                       ----------
General partners                                                                       $   36,630
                                                                                       ----------
                                                                                       ----------
Net income per limited partnership unit                                                $     5.64
                                                                                       ----------
                                                                                       ----------
</TABLE>

--------------------------------------------------------------------------------
                   STATEMENT OF CHANGES IN PARTNERS' CAPITAL
                             (going concern basis)
                     For the year ended September 30, 1996
<TABLE>
<CAPTION>
                                                              LIMITED       GENERAL
                                                             PARTNERS       PARTNERS        TOTAL
<S>                                                         <C>             <C>          <C>
----------------------------------------------------------------------------------------------------
Partners' capital--September 30, 1995                       $11,394,078     $203,638     $11,597,716
Net income                                                      302,004       36,630         338,634
Distributions                                                (1,267,825)     (23,299)     (1,291,124)
                                                            -----------     --------     -----------
Partners' capital--September 30, 1996                       $10,428,257     $216,969     $10,645,226
                                                            -----------     --------     -----------
                                                            -----------     --------     -----------
----------------------------------------------------------------------------------------------------
 
              The accompanying notes are an integral part of these statements.
</TABLE>
 
                                       4

<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                            STATEMENT OF CASH FLOWS
                             (going concern basis)
                     For the year ended September 30, 1996
<TABLE>
<S>                                                                                   <C>
-------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Rental income and deposits received                                                   $ 2,014,868
Interest received                                                                          28,000
Other income received                                                                      14,824
Property operating expenses paid                                                         (649,026)
Real estate taxes paid                                                                   (231,795)
General and administrative expenses paid                                                 (526,347)
Interest paid                                                                             (39,610)
                                                                                      -----------
Net cash provided by operating activities                                                 610,914
                                                                                      -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net proceeds from sale of land                                                          1,000,000
Property improvements                                                                    (187,934)
                                                                                      -----------
Net cash provided by investing activities                                                 812,066
CASH FLOWS FROM FINANCING ACTIVITIES
Distributions paid to partners                                                         (1,291,124)
                                                                                      -----------
 
Net increase in cash and cash equivalents                                                 131,856
Cash and cash equivalents at beginning of year                                          1,008,091
                                                                                      -----------
Cash and cash equivalents at end of year                                              $ 1,139,947
                                                                                      -----------
                                                                                      -----------
-------------------------------------------------------------------------------------------------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES
Net income                                                                            $   338,634
                                                                                      -----------
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation                                                                              136,271
Changes in:
Other assets                                                                                3,898
Accounts payable and accrued expenses                                                     156,541
Accrued real estate taxes                                                                  (6,459)
Due to affiliates                                                                         (18,874)
Deposits due to tenants                                                                     9,592
Unearned rental income                                                                     (8,689)
                                                                                      -----------
Total adjustments                                                                         272,280
                                                                                      -----------
Net cash provided by operating activities                                             $   610,914
                                                                                      -----------
                                                                                      -----------
-------------------------------------------------------------------------------------------------
 
          The accompanying notes are an integral part of these statements.
</TABLE>
 
                                       5

<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
                         NOTES TO FINANCIAL STATEMENTS
                               September 30, 1998
 
A. General
 
   Prudential-Bache/ Watson & Taylor, Ltd.-3 (the 'Partnership') is a Texas
limited partnership formed on November 13, 1984 and which will terminate in
accordance with a vote of the limited partners as described below. The
Partnership was formed for the purpose of acquiring, owning, developing and
operating self-storage and office/showroom warehouse complexes; investing in
unimproved commercial properties; and investing in first lien mortgage loans on
existing or to-be-constructed commercial income-producing properties. The
general partners of the Partnership are Prudential-Bache Properties, Inc.
('PBP'), a wholly-owned subsidiary of Prudential Securities Group Inc., George
S. Watson, and A. Starke Taylor, III (collectively, the 'General Partners'). PBP
is the Managing General Partner and is responsible for the day-to-day operations
of the Partnership and its investments.
 
   On December 15, 1995, the Management Committee of the Partnership determined
to seek bids for all of the properties held by the Partnership. On June 13,
1996, the Partnership entered into a contract with Public Storage, Inc., the
property manager of the Partnership's properties, for the sale of substantially
all the Partnership's properties. This sale was subject to the approval by the
limited partners holding a majority of the limited partnership units and certain
other conditions and potential price adjustments.
 
   In accordance with a consent statement dated September 17, 1996 (the 'Consent
Statement'), the limited partners approved, on October 18, 1996, the sale to
Public Storage, Inc. of all seven miniwarehouse facilities owned by the
Partnership. The properties were sold to Public Storage, Inc. and its affiliates
on October 31, 1996. The Partnership received, in cash, gross sales proceeds of
$11,050,000 reduced by certain selling expenses and pro-rations of approximately
$373,000. The sales proceeds were also reduced by the payment to third parties
of $644,000 representing the principal and accrued interest on the Partnership's
note payable secured by three of the properties sold to Public Storage, Inc. The
gross sales price was in excess of the appraised value of the properties. The
Partnership continues to own an undeveloped land parcel (I-35/I-20) located in
Dallas, Texas. It is uncertain at this time when the sale of this property will
occur.
 
   A distribution of $180 per limited partnership unit was made on November 14,
1996 representing the net sales proceeds reduced by a contingency reserve and
funds required to meet current and future operating costs until the liquidation
of the Partnership. The Partnership intends to liquidate as soon as possible,
subject to the sale of the remaining undeveloped land parcel, and will
distribute any remaining funds at such time.
 
B. Summary of Significant Accounting Policies
 
Basis of accounting
 
   The Partnership adopted the liquidation basis of accounting effective October
1, 1996. Accordingly, the net assets of the Partnership at September 30, 1998
and 1997 are stated at liquidation value, i.e., the assets have been valued at
their estimated net realizable values and the liabilities include estimated
amounts to be incurred through the date of liquidation of the Partnership. The
actual remaining net proceeds from liquidation will depend upon a variety of
factors and are likely to differ from the amounts reflected in the accompanying
financial statements. Prior to October 1, 1996, the books and records of the
Partnership were maintained on a going concern accrual basis of accounting. The
Partnership's fiscal year for both book and tax purposes ends on September 30.
 
Property
 
   Effective December 31, 1995, the Partnership reclassified its properties from
held for use to held for sale and ceased depreciating the properties for
financial reporting purposes only.
 
Cash and cash equivalents
 
   Cash and cash equivalents include money market funds whose cost approximates
market.
 
                                       6

<PAGE>
Income taxes
 
   The Partnership is not required to provide for, or pay, any Federal or state
income taxes. Income tax attributes that arise from its operations are passed
directly to the individual partners. The Partnership may be subject to other
state and local taxes in jurisdictions in which it operates.
 
Profit and loss allocations and distributions
 
   Net operating income before depreciation is allocated 92% to the limited
partners and 8% to the General Partners. Net operating loss, provision for loss
on impairment of assets, and depreciation are allocated 99% to the limited
partners and 1% to the General Partners. Distributions of cash from operations
are made in accordance with the Partnership Agreement and are allocated 92% to
the limited partners and 8% to the General Partners.
 
   Income from a Terminating Sale, as defined in the Partnership Agreement, is
allocated first to all partners having negative capital account balances, to the
extent of such balances, and then to the limited partners until their capital
accounts equal their Adjusted Capital Contribution plus a Cumulative Preference
as those terms are defined in the Partnership Agreement. Loss from a Terminating
Sale is first allocated to the General Partners to the extent of their positive
capital account balances. Sales proceeds from a Terminating Sale are first used
for the payment of any debts or obligations of the Partnership, then any balance
remaining is distributed to the partners having positive capital account
balances.
 
   Net income (loss) per limited partnership unit for all years presented is
based on 53,585 limited and equivalent units outstanding, which excludes 270
equivalent units held by PBP (see Note E) for which PBP has waived all of its
rights thereon.
 
C. Property Held for Sale
 
   The Partnership's properties at September 30, 1998 and 1997 were:
 
<TABLE>
<CAPTION>
                                                                             1998          1997
                                                                           --------      --------
<S>                                                                        <C>           <C>
Unimproved properties:
     I-35/I-20 - Dallas, Texas                                             $275,000      $275,000
                                                                           --------      --------
                                                                           --------      --------
</TABLE>
 
    The allowance for loss on impairment of assets has been allocated against
the carrying value of the properties as of September 30, 1997 and September 30,
1998.
 
    Pursuant to the Consent Statement dated September 17, 1996, the partnership
sold all of its improved properties to Public Storage, Inc. and its affiliates
on October 31, 1996. As of September 30, 1998, the Partnership continues to own
an undeveloped land parcel (I-35/I-20) in Dallas, Texas.
 
D. Note Payable
 
   On March 5, 1986, the Partnership purchased an 88.81% participating interest
in a $5,700,000 loan (the 'Loan') from First Commonwealth Mortgage Trust (the
'Lender') to TriProperties, Ltd. (the 'Borrower'), an affiliate of Messrs.
Watson and Taylor. The Loan was secured by the Mt. Holly, Eastgate and Quail
Valley properties (collectively, the 'Mortgaged Properties').
 
   On December 5, 1988, following the default by the Borrower under the Loan,
the Partnership and the Lender entered into an agreement whereby the Lender
assigned the note evidencing the Loan to the Partnership in exchange for the
Partnership's issuance to the Lender of a promissory note in the amount of
$638,000. The Partnership's promissory note bore interest, payable quarterly, at
a rate equal to 11.19% of net cash flow from the Mortgaged Properties and the
full amount thereof was due on January 30, 1999, the maturity date of the Loan.
Subsequently, the Partnership foreclosed and took title to each of the Mortgaged
Properties and granted a first lien on such properties to the Lender as
collateral for the Partnership's $638,000 promissory note. The note was paid in
full with accrued interest at the time of the sale of the Partnership's
miniwarehouse facilities.
 
   Interest expense on the promissory note was approximately $30,000 for the
year ended September 30, 1996.
 
                                       7

<PAGE>
E. Related Parties
 
   PBP and its affiliates perform services for the Partnership which include,
but are not limited to: accounting and financial management; transfer and
assignment functions; asset management (including direct management of the
Partnership's unimproved properties); investor communications; printing and
other administrative services. PBP and its affiliates receive reimbursements for
costs incurred in connection with these services, the amount of which is limited
by the provisions of the Partnership Agreement. The costs and expenses incurred
on behalf of the Partnership, which are reimbursable to PBP and its affiliates
for the year ended September 30, 1996, was $124,000.
 
   Affiliates of Messrs. Watson and Taylor, the individual General Partners,
also perform certain administrative and monitoring functions on behalf of the
Partnership. The Partnership recorded $43,000 relating to the reimbursement for
these services for the year ended September 30, 1996, of which approximately
$12,000 was an underaccrual from the previous year.
 
   In conjunction with the adoption of the liquidation basis of accounting, the
Partnership recorded an accrual as of September 30, 1998 and 1997 for the
estimated costs expected to be incurred to liquidate the Partnership. Included
in these estimated liquidation costs at September 30, 1998 and 1997 are $97,000
and $101,000, respectively, expected to be payable to the General Partners and
their affiliates during the anticipated remaining liquidation period. The actual
charges to be incurred by the Partnership will depend primarily upon the length
of time required to liquidate the Partnership's remaining net assets and may
differ from the amounts accrued as of September 30, 1998.
 
   PBP and the two individual General Partners of the Partnership, own 270, 135
and 135 equivalent limited partnership units, respectively. PBP receives funds
from the Partnership, such as General Partner distributions and reimbursement of
expenses, but has waived all of its rights resulting from its ownership of
equivalent limited partnership units. Accordingly, the 270 units owned by PBP
have been excluded from the calculation of net income per limited partnership
unit and distributions per limited partnership unit.
 
   Prudential Securities Incorporated, an affiliate of PBP, owns 253 limited
partnership units at September 30, 1998.
 
                                       8

<PAGE>
F. Income Taxes
 
   The following is a reconciliation of net income (loss) for financial
reporting purposes to net loss for tax reporting purposes for the years ended
September 30, 1998, 1997 and 1996, respectively:
 
<TABLE>
<CAPTION>
                                                               1998           1997           1996
<S>                                                          <C>           <C>             <C>
----------------------------------------------------------------------------------------------------
Net income (loss) per financial statements                   $ (76,752)(a) $   144,578(b)  $ 338,634
Tax depreciation in excess of book, net                             --         (20,037)     (327,949)
Carrying costs on land held for investment, capitalized for
  tax
  purposes                                                          --              --        35,030
Rent received in advance, reported as income for tax
  purposes                                                          --         (24,255)       24,255
Reversal of prior years' rents received in advance,
  reported as
  taxable income in prior years                                     --              --       (32,944)
Additional expenses included in taxable income                      --              --        (6,205)
Tax loss in excess of book on sale of land                          --              --      (860,519)
Tax loss in excess of book amount on sale of properties             --      (2,444,836)           --
Estimated liquidation costs recorded for financial statement
  purposes only                                                106,971         209,871            --
Estimated liquidation costs previously recorded for
  financial statement purposes deductible currently for tax
  purposes                                                    (164,590)             --            --
Costs related to sale of properties, capitalized for tax
  purposes                                                          --              --       313,633
                                                             ---------     -----------     ---------
Tax basis net loss                                           $(134,371)    $(2,134,679)    $(516,065)
                                                             ---------     -----------     ---------
                                                             ---------     -----------     ---------
(a) Represents a decrease in the estimated liquidation values of assets and liabilities which is
    reflected in the Statement of Changes in Net Assets as of September 30, 1998.
(b) Includes gain on sale of properties of $330,408, partially offset by a decrease in the estimated
    liquidation values of assets and liabilities of $185,830, which are reflected in the Statement
    of Changes in Net Assets as of September 30, 1997.
</TABLE>
 
   The differences between the tax basis and book basis of partners' capital are
primarily attributable to the cumulative effect of book to tax income
adjustments.
 
                                       9

<PAGE>
                    PRUDENTIAL-BACHE/WATSON & TAYLOR, LTD.-3
                            (a limited partnership)
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
 
Liquidity and Capital Resources
 
   As more fully described in Notes A and C to the financial statements, the
Partnership sold substantially all of its properties on October 31, 1996 for net
proceeds of $10,677,000. On November 14, 1996, the Partnership paid
distributions from the net proceeds of this sale in the amount of $180 per
limited partnership unit. The Partnership has retained funds for a contingency
reserve and to meet current and future operating costs until the liquidation of
the Partnership. The Partnership continues to own an undeveloped land parcel
located in Dallas, Texas. The Partnership intends to liquidate as soon as
possible, subject to the sale of the remaining undeveloped land parcel, and will
distribute any remaining funds at such time. Estimated costs expected to be
incurred through the date of liquidation of the Partnership have been accrued in
the accompanying financial statements.
 
Results of Operations
 
   As a result of the Partnership adopting the liquidation basis of accounting
in accordance with generally accepted accounting principles as of October 1,
1996 and thus not reporting results of operations thereafter, and the sale of
substantially all of the properties in October 1996, there is no management
discussion comparing the corresponding 1998, 1997 and 1996 periods.
 
Year 2000
 
   The Partnership has considered, and is taking appropriate actions to address,
the possible adverse effects of the Year 2000 on its systems and operations.
Accordingly, the Partnership believes the Year 2000 will not have significant
adverse effects on its systems and operations.
 
                                       10

<PAGE>
                               OTHER INFORMATION
 
   The Partnership's Annual Report on Form 10-K as filed with the Securities and
Exchange Commission is available to limited partners without charge upon written
request to:
 
        Prudential-Bache/Watson & Taylor, Ltd.-3
        P.O. Box 2016
        Peck Slip Station
        New York, NY 10272-2016
 
                                       11

<PAGE>
Peck Slip Station                              BULK RATE
P.O. Box 2016                                 U.S. POSTAGE
New York, NY 10272                                PAID
                                             Automatic Mail

PBW&T3/35643/171666