<PAGE>   1

                                   FORM 10-Q
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                   QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934  
                   ----------------------------------------

For Quarter Ended           September 30, 1996                              
                     ----------------------------------------------------------

Commission file number            0-16027                                   
                          -----------------------------------------------------

              REAL ESTATE INCOME PARTNERS III, LIMITED PARTNERSHIP            
-------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


                      Delaware                          13-3341425          
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            (State or other jurisdiction of          (I.R.S. Employer
             incorporation or organization)          Identification No.)


 27611 La Paz Road, P.O. Box A-1, Laguna Niguel, California    92677-0100   
-------------------------------------------------------------------------------
          (Address of principal executive offices)             (Zip Code)


                                  (714) 643-7700                              
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              (Registrant's telephone number, including area code)


                                       N/A                                    
-------------------------------------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report.)


Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 12(g), 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding twelve 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 
                                    ---          ---

<PAGE>   2
              REAL ESTATE INCOME PARTNERS III, LIMITED PARTNERSHIP
                         QUARTERLY REPORT ON FORM 10-Q
                 FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996
                 ---------------------------------------------
                 
                                     INDEX
                                     -----
                                     

<TABLE>
<CAPTION>
                                                                                                               Page
                                                                                                               ----
<S>              <C>                                                                                             <C>
PART I.          FINANCIAL INFORMATION

Item 1.          Financial Statements

                 Balance Sheets -
                 September 30, 1996 (Unaudited) and December 31, 1995 . . . . . . . . . . . . . . . . . .         3

                 Statements of Operations (Unaudited) -
                 Three and Nine Months Ended September 30, 1996 and 1995  . . . . . . . . . . . . . . . .         4

                 Statements of Cash Flows (Unaudited) -
                 Nine Months Ended September 30, 1996 and 1995  . . . . . . . . . . . . . . . . . . . . .         5

                 Notes to Financial Statements (Unaudited)  . . . . . . . . . . . . . . . . . . . . . . .         6

Item 2.          Management's Discussion and Analysis of
                 Financial Condition and Results of Operations  . . . . . . . . . . . . . . . . . . . . .         9


PART II.         OTHER INFORMATION  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         14
</TABLE>





                                       2
<PAGE>   3
                         PART I.  FINANCIAL INFORMATION
                         ------------------------------

ITEM 1.  FINANCIAL STATEMENTS
         --------------------

              REAL ESTATE INCOME PARTNERS III, LIMITED PARTNERSHIP
                                 BALANCE SHEETS                   
              ----------------------------------------------------
<TABLE>
<CAPTION>
                                                                     September 30,              December 31,
                                                                         1996                       1995    
                                                                    --------------              ------------
                                                                      (Unaudited)                 (Note)
<S>                                                                   <C>                       <C>
ASSETS
------

Properties held for sale (net of valuation
   allowance of $1,010,000 in 1996 and
   $1,000,000 in 1995)                                                $27,210,000              $29,457,000

Investment in Cooper Village Partners                                   2,903,000                2,916,000
Cash and cash equivalents                                                 860,000                  980,000
Accounts receivable (net of allowance for
   doubtful accounts of $13,000 in 1996 and
  $14,000 in 1995)                                                         26,000                   71,000
Accrued rent receivable                                                   799,000                  799,000
Prepaid expenses and other assets                                         628,000                  627,000 
                                                                      -----------              -----------

                                                                      $32,426,000              $34,850,000 
                                                                      ===========              ===========

LIABILITIES AND PARTNERS' CAPITAL
---------------------------------

Accounts payable and accrued liabilities                              $   475,000              $   448,000 
                                                                      -----------              -----------

Partners' capital (deficit):
   Limited Partners                                                    32,159,000               34,607,000
   General Partner                                                       (208,000)                (205,000)
                                                                      -----------              -----------
                                                                        31,951,00               34,402,000

Commitments and contingencies                                                   -                        - 
                                                                      -----------              -----------

                                                                      $32,426,000              $34,850,000 
                                                                      ===========              ===========
</TABLE>





Note:  The balance sheet at December 31, 1995 has been prepared from the
       audited financial statements as of that date.



The accompanying notes are an integral part of these financial statements.





                                       3
<PAGE>   4
              REAL ESTATE INCOME PARTNERS III, LIMITED PARTNERSHIP
                            STATEMENTS OF OPERATIONS
                                   (UNAUDITED)                    
              ----------------------------------------------------

<TABLE>
<CAPTION>
                                                Three Months Ended                         Nine Months Ended
                                                   September 30,                              September 30,       
                                          -------------------------------          -------------------------------
                                             1996                1995                  1996                1995   
                                          ----------           ----------          ----------           ----------
<S>                                       <C>                  <C>                 <C>                  <C>
REVENUES
--------

Rental income                             $1,228,000           $1,304,000          $3,623,000           $3,869,000
Interest income                               12,000               20,000              41,000               49,000
Gain/(loss) on disposition
 of assets                                         -                    -             (13,000)                   -
                                          ----------           ----------          ----------           ----------

  Total revenues                           1,240,000            1,324,000           3,651,000            3,918,000
                                          ----------           ----------          ----------           ----------

EXPENSES
--------

Operating expenses                           315,000              316,000             900,000               933,000
Real estate taxes                            151,000              138,000             451,000               500,000
Depreciation and amortization                 32,000              437,000              98,000             1,234,000
General and administrative                   201,000              170,000             570,000               558,000
Adjustment to carrying value
 of real estate                              416,000                    -             610,000                    -
                                          ----------           ----------          ----------           ----------

  Total Expenses                           1,115,000            1,061,000           2,629,000            3,225,000
                                          ----------          ----------           ----------           ----------

Income before equity
 in earnings                                 125,000              263,000           1,022,000               693,000

Equity in earnings of Cooper
  Village Partners                            47,000               26,000             205,000               86,000
                                          ----------           ----------          ----------           ----------

NET INCOME                                $  172,000           $  289,000          $1,227,000           $  779,000
                                          ==========           ==========          ==========           ==========

NET INCOME ALLOCABLE TO:

  General Partner                         $    2,000           $    3,000          $   12,000           $    8,000
                                          ==========           ==========          ==========           ==========

  Limited Partners                        $  170,000           $  286,000          $1,215,000           $  771,000
                                          ==========           ==========          ==========           ==========
</TABLE>





The accompanying notes are an integral part of these financial statements.





                                       4
<PAGE>   5
              REAL ESTATE INCOME PARTNERS III, LIMITED PARTNERSHIP
                            STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)                    
              ----------------------------------------------------

<TABLE>
<CAPTION>
                                                                        Nine Months Ended September 30,
                                                                        -------------------------------
                                                                      1996                            1995    
                                                                  -------------                   ------------
<S>                                                                <C>                            <C>

Cash flows from operating activities:
   Net income                                                      $ 1,227,000                    $   779,000
Adjustments to reconcile net income to
net cash provided by operating activities:
   Depreciation and amortization                                        98,000                     1,234,000
   Equity in earnings of Cooper Village
     Partners                                                         (205,000)                      (86,000)
   Adjustment to carrying value of real estate                         610,000                             -
  Loss on disposition of assets                                         13,000                             -
Changes in:
   Additions to properties held for sale                              (530,000)                            -
   Accounts receivable                                                  45,000                       (30,000)
   Accrued rent receivable                                                   -                       (51,000)
   Prepaid expenses and other assets                                   (98,000)                      (44,000)
   Accounts payable and accrued liabilities                             27,000                        84,000 
                                                                   -----------                    ----------
Net cash provided by operating activities                            1,187,000                     1,886,000

Cash flows from investing activities:
   Investment in real estate                                         2,153,000                       (234,000)
   Distributions received from
    Cooper Village Partners                                            218,000                        172,000 
                                                                   -----------                    -----------
Net cash provided by(used in)investing
    activities                                                       2,371,000                       (62,000)

Cash flows from financing activities:
   Distributions                                                    (3,678,000)                    (1,358,000)
                                                                   -----------                    -----------
Net cash used in financing activities                               (3,678,000)                    (1,358,000)

Net (decrease) increase in cash and
  cash equivalents                                                    (120,000)                      466,000

Cash and cash equivalents, beginning of
   period                                                              980,000                      1,085,000 
                                                                   -----------                    -----------

Cash and cash equivalents, end of period                           $   860,000                    $ 1,551,000 
                                                                   ===========                    ===========
</TABLE>





The accompanying notes are an integral part of these financial statements.





                                       5
<PAGE>   6
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


NOTES TO FINANCIAL STATEMENTS - UNAUDITED
-----------------------------------------

(1)      Accounting Policies
         -------------------
         
         The financial statements of Real Estate Income Partners III, Limited
         Partnership (the "Partnership") included herein have been prepared by
         the General Partner, without audit, pursuant to the rules and
         regulations of the Securities and Exchange Commission.  These
         financial statements include all adjustments which are of a normal
         recurring nature and, in the opinion of the General Partner, are
         necessary for a fair presentation.  Certain information and footnote
         disclosures normally included in financial statements prepared in
         accordance with generally accepted accounting principles have been
         condensed or omitted, pursuant to the rules and regulations of the
         Securities and Exchange Commission.  These financial statements should
         be read in conjunction with the financial statements and notes thereto
         included in the Partnership's annual report on Form 10-K for the year
         ended December 31, 1995.

         Earnings Per Unit

         The Partnership Agreement does not designate investment interests in
         units.  All investment interests are calculated on a "percent of
         Partnership" basis, in part to accommodate reduced rates on sales
         commissions for subscriptions in excess of certain specified amounts.

         A Limited Partner who was charged a reduced sales commission or no
         sales commission was credited with proportionately larger Invested
         Capital and therefore had a disproportionately greater interest in the
         capital and revenues of the Partnership than a Limited Partner who
         paid commissions at a higher rate.  As a result, the Partnership has
         no set unit value as all accounting, investor reporting and tax
         information is based upon each investor's relative percentage of
         Invested Capital.  Accordingly, earnings or loss per unit is not
         presented in the accompanying financial statements.

         Carrying Value of Real Estate

         In March 1995, the Financial Accounting Standards Board issued
         Statement of Financial Accounting Standards No. 121 "Accounting for
         the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
         Disposed Of," ("FAS 121").  This Statement requires that if the
         General Partner believes factors are present that may indicate
         long-lived assets are impaired, the undiscounted cash flows, before
         debt service, related to the assets should be estimated.  If these
         estimated cash flows are less than the carrying value of the asset,
         then impairment is deemed to exist.  If impairment exists, the asset
         should be written down to the estimated fair value.





                                       6
<PAGE>   7
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


NOTES TO FINANCIAL STATEMENTS - UNAUDITED (Cont'd.)
-----------------------------------------

(1)      Accounting Policies (Cont'd.)
         -------------------

         Further, assets held for sale, including any unrecoverable accrued
         rent receivable or capitalized leasing commissions, should be carried
         at the lower of carrying value or fair value less estimated selling
         costs.  Any adjustment to carrying value is recorded as a valuation
         allowance against property held for sale.  Each reporting period, the
         General Partner will review its estimates of fair value, which may be
         decreased or increased up to the original carrying value.  Finally,
         assets held for sale are no longer depreciated.  The General Partner
         adopted FAS 121 at December 31, 1995 and the adoption did not have a
         material impact on the Partnership's operations or financial position,
         as prior to December 31, 1995, the Partnership had not had any
         properties held for sale.

         As noted above, as of December 31, 1995, the General Partner decided
         to account for the Partnership's properties as assets held for sale,
         assuming an average 12 month holding period, instead of for
         investment.  Accordingly, the General Partner compared the carrying
         value of each property to its appraised value as of January 1, 1996.
         If the carrying value of the property and certain related assets was
         greater than its appraised value, less selling costs, the General
         Partner reduced the carrying value of the property by the difference.
         Using this methodology, as of December 31, 1995, the General Partner
         determined that Creek Edge Business Center, Flaircentre and NorthTech
         had carrying values greater than their appraised values, and therefore
         reduced those carrying values by $50,000, $600,000 and $350,000 to
         $3,802,000, $2,155,000 and $13,934,000, respectively.

         For the three and nine months ended September 30, 1996, the
         Partnership spent approximately $416,000 and $610,000, respectively,
         related to tenant/building improvements and leasing commissions at
         Creek Edge Business Center.  Because these expenditures exceeded the
         estimate of fair value of that property as of December 31, 1995, the
         General Partner adjusted the carrying value of the Partnership's
         portfolio by $610,000 for the nine months ended September 30, 1996.

(2)      Transactions with Affiliates
         ----------------------------
         
         The Partnership has no employees and, accordingly, the General Partner
         and its affiliates perform services on behalf of the Partnership in
         connection with administering the affairs of the Partnership.  The
         General Partner and affiliates are reimbursed for their general and
         administrative costs actually incurred and associated with services
         performed on behalf of the Partnership.  For the three months ended
         September 30, 1996 and 1995, the Partnership incurred approximately
         $39,000 and $39,000, respectively, of such expenses.  For the nine
         months ended September 30, 1996 and 1995, such payments were $106,000
         and $122,000 respectively.





                                       7
<PAGE>   8
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


NOTES TO FINANCIAL STATEMENTS - UNAUDITED (Cont'd.)
-----------------------------------------

(2)      Transactions with Affiliates Cont'd.
         ----------------------------

         An affiliate of the General Partner provides property management
         services with respect to the Partnership's properties and receives a
         fee for such services not to exceed 6% of the gross receipts from the
         properties under management provided leasing services are performed,
         otherwise not to exceed 3%.  Such fees amounted to approximately
         $47,000 and $49,000, respectively, for the three months ended
         September 30, 1996 and 1995, respectively, and $140,000 and $142,000
         for the nine months ended September 30, 1996 and 1995, respectively.
         In addition, an affiliate of the General Partner received $10,000 and
         $26,000 for the three months ended September 30, 1996 and 1995,
         respectively, as reimbursement of costs of on-site property management
         personnel and other reimbursable costs.  For the nine months ended
         September 30, 1996 and 1995, such payments were $43,000 and $78,000,
         respectively.

         As previously reported, on June 24, 1993, the Partnership completed
         its solicitation of written consent from its Limited Partners.  A
         majority in interest of the Partnership's Limited Partners approved
         each of the proposals contained in the Information Statement dated May
         5, 1993.  Those proposals have been implemented by the Partnership as
         contemplated by the Information Statement as amendments to the
         Partnership Agreement, and are reflected in these financial statements
         as such.

         The Amended Partnership Agreement provides for the Partnership's
         payment to the General Partner of an annual asset management fee equal
         to .75% of the aggregate appraised value of the Partnership's
         properties as determined by independent appraisal undertaken in
         January of each year.  Such fees amounted to $54,000 and $60,000 for
         the three months ended September 30, 1996 and 1995, respecively, and
         for the nine months ended September 30, 1996 and 1995,  $170,000 and
         $180,000, respectively.  In addition, the Amended Partnership
         Agreement provides for payment to the General Partner of a leasing fee
         for services rendered in connection with leasing space in a
         Partnership property after the expiration or termination of leases.
         Fees for leasing services for the three months ended September 30,
         1996 and 1995 amounted to $17,000 and $0, respectively.  For the nine
         months ended September 30, 1996 and 1995, such fees  amounted to
         $43,000 and $23,000, respectively.

         In addition to the aforementioned, the General Partner was also paid
         $13,000 and $15,000 related to the Partnership's portion (42%) of
         asset management fees, property management fees, leasing fees and
         reimbursement of on-site personnel and other reimbursable expenses for
         Cooper Village Partners for the three months ended September 30, 1996
         and 1995, respectively.  For the nine months ended September 30, 1996
         and 1995, such cost were $44,000 and $45,000 respectively.





                                       8
<PAGE>   9
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


NOTES TO FINANCIAL STATEMENTS - UNAUDITED (Cont'd.)
-----------------------------------------

(3)      Loss on Disposition of Assets
         -----------------------------
         
         On June 4, 1996, the Partnership sold Flaircentre, an office complex
         composed of 11 one-story buildings in El Monte, California to an
         unaffiliated third party.  The sales price was $2,300,000 and the net
         proceeds of the sale amounted to approximately $2,153,000.  In
         December 1995, the General Partner had adjusted the carrying value of
         the property in accordance with the guidelines of FAS 121, which
         resulted in a write-down of  $600,000 and an adjusted carrying value
         of $2,155,000.  The resulting loss on sale, after taking into
         consideration all costs of the disposition, amounted to $13,000 as
         reflected on the Statement of Operations.  The General Partner was not
         paid a commission or disposition fee as part of this transaction.

(4)      Commitments and Contingencies
         -----------------------------
         
         The Partnership is not a party to any pending legal proceedings other
         than ordinary routine litigation incidental to its business.  It is
         the  General Partner's belief that the outcome of these proceedings
         will not be material to the business or financial condition of the
         Partnership.

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         Liquidity and Capital Resources
         -------------------------------
         
         Since completion of its acquisition program in December 1988, the
         Partnership has been engaged primarily in the operation of its
         properties. The Partnership's objective has been to hold its
         properties as long-term investments, although properties may be sold
         at any time depending upon the General Partner's judgment of the
         anticipated remaining economic benefits of continued ownership.
         Working capital is and will be provided principally from the operation
         of the Partnership's properties.  The Partnership may incur mortgage
         indebtedness relating to such properties by borrowing funds primarily
         to fund capital improvements or to obtain sale or financing proceeds
         for distribution to the Partners.

         Certain of the Partnership's properties are not fully leased.  The
         Partnership is actively marketing the vacant space in these
         properties, subject to the competitive environment in each of the
         market areas.  To the extent the Partnership is not successful in
         maintaining or increasing occupancy levels at these properties, the
         Partnership's future cash flow and distributions may be reduced.

         Quarterly distributions through September 30, 1996 represent cash flow
         generated from operations of the Partnership's properties and interest
         earned on the Partnership's working capital, net of capital reserve
         requirements.  In June 1996, the Partnership made a special
         distribution





                                       9
<PAGE>   10
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Cont'd.)

         Liquidity and Capital Resources (Cont'd.)
         -------------------------------

         of substantially all of the net proceeds from the sale of Flaircentre.
         Future cash distributions will be made principally to the extent of:
         cash flow attributable to operations; sales of the Partnership's
         properties; and, interest earned on the investment of capital
         reserves, net of future capital improvements to the Partnership's
         properties and an allowance for future capital reserves.

         In accordance with the terms of the Partnership Agreement, each year
         the Partnership secures an independent appraisal of each of the
         Partnership's properties as of January 1.  Prior to the January 1,
         1995 appraisals, the independent appraiser had estimated each
         property's "Investment Value," utilizing a seven to ten-year cash flow
         model to estimate value based upon an income approach.

         The Amendment to the Partnership Agreement consented to by the Limited
         Partners in June 1993 mandated, among other things, that the General
         Partner seek a vote of (and provide an analysis and recommendation to)
         the Limited Partners no later than December 31, 1996 regarding the
         prompt liquidation of the Partnership in the event that properties
         with (then) current appraised values constituting at least one-half of
         the total (then) current appraised values of all of the Partnership's
         properties are not sold or under contract for sale by the end of 1996.

         Given that mandate, the General Partner requested that the appraiser
         provide an assessment of value that reflects a shorter investment
         holding term.  Although the General Partner does not currently have a
         specific liquidation plan for the Partnership's properties, it
         requested that the appraiser assume that the entire portfolio would be
         sold over four years, in connection with the January 1995 appraisals
         and over three years in connection with the January 1996 appraisals.

         Using the shorter-term investment methodology that is consistent with
         the mandate of the 1993 Amendment to the Partnership Agreement, the
         appraiser estimated the value of the Partnership's properties at
         January 1, 1996 to be approximately $33,857,000, or $5,329 per $10,000
         original investor subscription.

         Over the past year, the General Partner has examined several
         alternative methods to achieve the Partnership's goal of selling
         properties and liquidating the Partnership at the earliest practicable
         time consistent with achieving reasonable value for the Limited
         Partners' investment.  As explained in the Partnership's May 5, 1993
         Information Statement, "achieving reasonable value" has meant for the
         Partnership to balance receiving higher sales prices per property than
         their 1993 values while at the same time not waiting forever to sell
         at a theoretical "top of the market."  Alternatives under
         consideration by the General Partner may include a property-by-
         property liquidation or selling all of the





                                       10
<PAGE>   11
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Cont'd.)

         Liquidity and Capital Resources (Cont'd.)
         -------------------------------

         properties as a single portfolio.  The General Partner has had
         preliminary discussions regarding disposition, in whole or in
         part, of the Partnership's properties with various potential
         purchasers of some or all of the Partnership's portfolio.

         In connection with its consideration of these alternatives, the
         General Partner  has decided to treat its properties as held for sale
         instead of for investment for financial statement purposes.  In
         accordance with Statement of Financial Accounting Standards No. 121
         "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
         Assets to Be Disposed Of," the carrying value of these properties was
         evaluated to ensure that each property was carried on the
         Partnership's Balance Sheet at the lower of cost or fair value less
         estimated selling costs.  The General Partner estimated fair value for
         this purpose based on appraisals performed as of January 1, 1996.
         However, fair value can only be determined based upon sales to third
         parties, and sales proceeds could differ substantially.

         Based upon the General Partner's survey of the current marketplace,
         the General Partner believes, in fact, that in the relatively short
         term the Partnership's properties could generate sales prices that, in
         the aggregate, could be materially less than their aggregate appraised
         values based upon an "Investment Value" appraisal model.  The amount
         of the possible variance between the aggregate appraised values and
         potential sales prices cannot be reliably estimated at this time,
         because of the numerous variables that could affect the sales prices,
         including but not limited to the time frame in which the properties
         must be sold, method of sale (property-by-property or single
         transaction), prevailing capitalization rates at which comparable
         properties are being sold at the time of the Partnership's sales,
         constantly changing local market conditions and the state of leasing
         negotiations and capital expenditures for the properties at the time
         of sale.

         On June 4, 1996, the Partnership sold Flaircentre, a complex composed
         of 11, one-story office buildings located on 3.7 acres of land in El
         Monte, California, to The Evangelical Formosan Church, a California
         corporation.  The sale price was $2,300,000.  Net proceeds of the sale
         to the Partnership, after payment of commissions and closing costs,
         were approximately $2,153,000.  The General Partner was not paid a
         commission or disposition fee as part of this transaction.





                                       11
<PAGE>   12
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Cont'd.)

         Results of Operations for the Three Months Ended September 30, 1996
         -------------------------------------------------------------------
         Compared With the Three Months Ended September 30, 1995 and for the
         -------------------------------------------------------------------
         Nine Months Ended September 30, 1996 Compared With the Nine Months
         ------------------------------------------------------------------
         Ended September 30, 1995.
         -------------------------

         The decreases in revenue for the three and nine months ended September
         30, 1996, as compared to the corresponding periods in 1995, were
         primarily attributable to the loss of rental revenue associated with
         the sale of Flaircentre on June 4, 1996.  The aforementioned decreases
         were partially offset by increased revenue at NorthTech ($72,000),
         which resulted from the commencement of International Data Product's
         lease effective March 1, 1996.

         Interest income resulted from the temporary investment of Partnership
         working capital.  The decreases for the three and nine months ended
         September 30, 1996, as compared to the corresponding periods in 1995,
         were attributable to the  decreases in the average level of working
         capital available for investment during 1996.

         On June 4, 1996, the Partnership sold Flaircentre, a complex composed
         of 11, one-story office buildings located on 3.7 acres of land in El
         Monte, California, to The Evangelical Formosan Church, a California
         corporation.  The sale price was $2,300,000.  Net proceeds of the sale
         to the Partnership, after payment of commissions and closing costs,
         were approximately $2,153,000.  The General Partner was not paid a
         commission or disposition fee as part of this transaction.

         The decrease in operating expenses for the nine months ended September
         30, 1996, as compared to the corresponding period in 1995, was
         primarily attributable to the sale of Flaircentre in June 1996.

         The increase in real estate taxes for the  three months ended
         September 30, 1996,  as compared to the same period in 1995, was
         primarily attributable to a $40,000 refund which was the result of a
         successful tax appeal during the third quarter of 1995.  That refund
         was accounted for as a reduction of 1995 real estate tax expenses.

         The decrease in real estate taxes for the nine months ended September
         30, 1996, as compared to the corresponding period in 1995, was
         primarily attributable to the decrease in real estate taxes at
         Flaircentre that resulted from the sale of the property in June 1996.
         In addition, at NorthTech, a successful real estate tax appeal
         resulted in a $44,000 refund during the second quarter of 1996, which
         was offset against the quarter's aggregate real estate tax expenses.





                                       12
<PAGE>   13
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Cont'd.)

         Results of Operations for the Three Months Ended September 30, 1996
         -------------------------------------------------------------------
         Compared With the Three Months Ended September 30, 1995 and the Nine
         --------------------------------------------------------------------
         Months Ended September 30, 1996 Compared With the Nine Months Ended
         -------------------------------------------------------------------
         September 30, 1995. (Cont'd.)
         -------------------

         The decreases in depreciation and amortization expenses for the three
         and nine months ended September 30, 1996, as compared to the
         corresponding periods in 1995, were attributable to the adoption of
         Statement of Financial Accounting Standards, No. 121, "Accounting for
         the Impairment of Long-Lived Assets or Long-Lived Assets to Be
         Disposed Of," pursuant to which "assets held for sale" are no longer
         depreciated.

         For the nine months ended September 30, 1996, the carrying value of
         the Partnership's portfolio was reduced by $610,000, which is
         representative of the amount spent on tenant improvements, leasing
         commissions and other related assets at Creek Edge Business Center.

         The increases in equity in earnings of Cooper Village Partners for the
         three and nine months ended September 30, 1996, as compared to the
         corresponding periods in 1995, were primarily attributable to the
         Partnership's portion (42%) of depreciation expenses incurred during
         1995, of $25,000 and $77,000, respectively.  As previously discussed,
         the Partnership no longer depreciates its assets due to the adoption
         of Financial Accounting Standard No. 121.  In addition, during the
         nine months ended September 30, 1996, a lease termination settlement
         in the amount of $127,000 was collected from The Boston Stores which
         was taken into income at the end of the first quarter.

         General and administrative expenses for the nine months ended
         September 30, 1996 and 1995, included charges of $319,000 and
         $326,000, respectively, from the General Partner and its affiliates
         for services rendered in connection with administering the affairs of
         the Partnership and operating the Partnership's properties.  Also
         included in general and administrative expenses for the nine months
         ended September 30, 1996 and 1995, are direct charges of $251,000 and
         $232,000, respectively, relating to audit fees, tax preparation fees,
         legal and professional fees, insurance expenses, costs incurred in
         providing information to the Limited Partners and other miscellaneous
         costs.

         The increases in general and administrative expenses for the three and
         nine month periods ended September 30, 1996, as compared to the
         corresponding periods in 1995, were primarily attributable to the
         increases in leasing fees and professional services in 1996.





                                       13
<PAGE>   14
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


                          PART II.  OTHER INFORMATION
                          ---------------------------

ITEM 1.  LEGAL PROCEEDINGS
         -----------------
         
         So far as is known to the General Partner, neither the Partnership nor
         its properties are subject to any material pending legal proceedings.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K
         --------------------------------
         
         a)      Exhibits:

                 27 - Financial Data Schedule

         b)      Reports on Form 8-K:

                 None filed in quarter ended September 30, 1996





                                       14
<PAGE>   15
                        REAL ESTATE INCOME PARTNERS III,
                              LIMITED PARTNERSHIP


                                   SIGNATURES
                                   ----------
                                   

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.




REAL ESTATE INCOME PARTNERS III,
LIMITED PARTNERSHIP


By: BIRTCHER/LIQUIDITY         By: BIRTCHER INVESTORS,
    PROPERTIES                     a California limited partnership
         (General Partner)
                                   By: BIRTCHER INVESTMENTS,
                                       a California general partnership,
                                       General Partner of Birtcher Investors

                                       By: BIRTCHER LIMITED,
                                           a California limited partnership,
                                           General Partner of Birtcher 
                                           Investments

                                           By: BREICORP,
                                               a California corporation,
                                               formerly known as Birtcher
                                               Real Estate Inc., General
                                               Partner of Birtcher Limited

Date:    November 12, 1996                     By: /s/ Robert M. Anderson
                                                   -------------------------
                                                   Robert M. Anderson
                                                   Executive Director
                                                   BREICORP

                               By: LF Special Fund I, L.P.,
                                   a California limited partnership

                                   By: Liquidity Fund Asset Management, Inc.,
                                       a California corporation, General
                                       Partner of LF Special Fund I, L.P.

Date:    November 12, 1996             By: /s/ Brent R. Donaldson
                                           ----------------------------------
                                           Brent R. Donaldson
                                           President
                                           Liquidity Fund Asset Management, 
                                           Inc.





                                       15