FORM 10-QSB--QUARTERLY OR TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF
                     THE SECURITIES EXCHANGE ACT OF 1934
                        Quarterly or Transitional Report


                   U.S. Securities And Exchange Commission
                             Washington, D.C. 20549

                                   Form 10-QSB

(Mark One)
[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

              For the quarterly period ended September 30, 2001


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


             For the transition period from _________to _________

                         Commission file number 0-15676


                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.
      (Exact name of small business issuer as specified in its charter)



           Delaware                                              62-1242599
(State or other jurisdiction of                               (I.R.S. Employer
 incorporation or organization)                              Identification No.)

                       55 Beattie Place, P.O. Box 1089
                       Greenville, South Carolina 29602
                   (Address of principal executive offices)

                                 (864) 239-1000
                           (Issuer's telephone number)


Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 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___



<PAGE>



                         PART I - FINANCIAL INFORMATION


ITEM 1.     FINANCIAL STATEMENTS

a)

                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                           CONSOLIDATED BALANCE SHEET
                                   (Unaudited)
                       (in thousands, except unit data)


                               September 30, 2001

<TABLE>
<CAPTION>

Assets
<S>                                                                          <C>
   Cash and cash equivalents                                                 $   195
   Receivables and deposits                                                      228
   Restricted escrows                                                             87
   Other assets                                                                  284
   Investment properties:
      Land                                                    $ 2,821
      Buildings and related personal property                   34,252
                                                                37,073
      Less accumulated depreciation                            (20,930)       16,143
                                                                            $ 16,937

Liabilities and Partners' Deficit
Liabilities
   Accounts payable                                                          $   345
   Tenant security deposit liabilities                                            83
   Accrued property taxes                                                        424
   Other liabilities                                                             231
   Due to affiliates                                                             217
   Mortgage notes payable                                                     23,416

Partners' Deficit
   General partners                                            $ (155)
   Limited partners (1,011.5 units issued and
      outstanding)                                              (7,624)       (7,779)
                                                                            $ 16,937

         See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>

b)


                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                       (in thousands, except unit data)
<TABLE>
<CAPTION>


                                        Three Months Ended         Nine Months Ended
                                           September 30,             September 30,
                                         2001         2000         2001          2000

Revenues:
<S>                                  <C>          <C>           <C>          <C>
  Rental income                      $ 1,221      $ 1,405       $ 3,903      $ 4,232
  Other income                           134          154           483          423
  Casualty gain                           47           --            47           --
      Total revenues                   1,402        1,559         4,433        4,655

Expenses:
  Operating                              733          586         2,073        1,753
  General and administrative              63          102           188          193
  Depreciation                           429          389         1,293        1,186
  Interest                               536          541         1,608        1,616
  Property taxes                          98          102           342          260
      Total expenses                   1,859        1,720         5,504        5,008

Net loss                              $ (457)      $ (161)     $ (1,071)      $ (353)

Net loss allocated to general
  partners (2%)                         $ (9)        $ (3)        $ (21)        $ (7)
Net loss allocated to limited
  partners (98%)                        (448)        (158)       (1,050)        (346)

                                      $ (457)      $ (161)     $ (1,071)      $ (353)

Net loss per limited partnership
  unit                               $(442.90)    $(156.20)   $(1,038.06)    $(342.07)

         See Accompanying Notes to Consolidated Financial Statements
</TABLE>


<PAGE>

c)

                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

            CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT
                                   (Unaudited)
                       (in thousands, except unit data)

<TABLE>
<CAPTION>
                                       Limited
                                     Partnership     General      Limited
                                        Units        Partners    Partners     Total

<S>                                    <C>             <C>        <C>        <C>
Original capital contributions         1,013.0         $ 1        $20,240    $20,241

Partners' deficit at
   December 31, 2000                   1,011.5        $ (134)     $(6,574)   $(6,708)

Net loss for the nine months
   ended September 30, 2001                 --           (21)      (1,050)    (1,071)

Partners' deficit at
   September 30, 2001                  1,011.5        $ (155)     $(7,624)   $(7,779)

         See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>

d)
                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                (in thousands)
<TABLE>
<CAPTION>

                                                                    Nine Months Ended
                                                                      September 30,
                                                                    2001         2000
Cash flows from operating activities:
<S>                                                              <C>          <C>
  Net loss                                                       $(1,071)     $ (353)
  Adjustments to reconcile net loss to net cash
   provided by operating activities:
     Depreciation                                                  1,293        1,186
     Amortization of mortgage discounts and loan costs                50           50
     Casualty gain                                                   (47)          --
     Change in accounts:
      Receivables and deposits                                       (89)         (66)
      Other assets                                                   (36)         (39)
      Accounts payable                                               220           (8)
      Tenant security deposit liabilities                            (30)           8
      Accrued property taxes                                         188          149
      Other liabilities                                               35         (115)
      Due to affiliate                                                76           81
         Net cash provided by operating activities                   589          893

Cash flows from investing activities:
  Property improvements and replacements                            (890)        (567)
  Net deposits to restricted escrows                                  (8)         (69)
  Insurance proceeds received                                         68           --
         Net cash used in investing activities                      (830)        (636)

Cash flows from financing activities:
  Payments on mortgage notes payable                                (111)        (102)
  Advances from affiliates                                           156           73
  Payments on advances from affiliates                               (68)          (9)
         Net cash used in financing activities                       (23)         (38)

Net (decrease) increase in cash and cash equivalents                (264)         219
Cash and cash equivalents at beginning of period                     459          480

Cash and cash equivalents at end of period                         $ 195        $ 699

Supplemental disclosure of cash flow information:
  Cash paid for interest                                         $ 1,557      $ 1,566

Included in property  improvements  and  replacements  for the nine months ended
September   30,  2001  and  2000  are   approximately   $240,000   and  $78,000,
respectively,  of  improvements  which  were  included  in  accounts  payable at
December 31, 2000 and 1999.

         See Accompanying Notes to Consolidated Financial Statements

</TABLE>

<PAGE>
e)

                  DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

Note A - Basis of Presentation

The  accompanying   unaudited  consolidated  financial  statements  of  Davidson
Diversified Real Estate III, L.P. (the  "Partnership" or "Registrant") have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-QSB and Item 310(b)
of Regulation S-B.  Accordingly,  they do not include all of the information and
footnotes  required by generally  accepted  accounting  principles  for complete
financial statements.  In the opinion of Davidson Diversified  Properties,  Inc.
(the  "Managing  General  Partner"),   all  adjustments  (consisting  of  normal
recurring  accruals)  considered  necessary  for a fair  presentation  have been
included. Operating results for the three and nine month periods ended September
30, 2001 are not necessarily  indicative of the results that may be expected for
the year  ending  December  31,  2001.  For  further  information,  refer to the
consolidated   financial  statements  and  footnotes  thereto  included  in  the
Partnership's Annual Report on Form 10-KSB for the year ended December 31, 2000.
The  Managing  General  Partner  is  a  wholly  owned  subsidiary  of  Apartment
Investment  and  Management  Company  ("AIMCO"),  a publicly  traded real estate
investment trust.

Principles of Consolidation

The financial  statements include all of the accounts of the Partnership and its
99.9% limited partnership interest in Plainview Apartments,  L.P. and its wholly
owned Limited Liability Corporation, Salem GP, LLC. The managing general partner
of Plainview Apartments,  L.P., is Davidson Diversified  Properties,  Inc. which
may be removed  as the  managing  general  partner  of this  partnership  by the
Registrant;  therefore,  the  partnership is controlled and  consolidated by the
Registrant. All significant interpartnership balances have been eliminated.

Segment Reporting

Statement of Financial  Accounting Standards ("SFAS") No. 131, "Disclosure about
Segments of an Enterprise and Related Information" established standards for the
way that public business enterprises report information about operating segments
in annual  financial  statements  and  required  that those  enterprises  report
selected  information about operating segments in interim financial reports.  It
also established  standards for related disclosures about products and services,
geographic  areas,  and  major  customers.  As  defined  in SFAS  No.  131,  the
Partnership  has only one  reportable  segment.  The  Managing  General  Partner
believes that  segment-based  disclosures  will not result in a more  meaningful
presentation than the consolidated financial statements as currently presented.

Reclassifications

Certain  of the 2000  balances  have been  reclassified  to  conform to the 2001
presentation.

Note B - Transactions with Affiliated Parties

The  Partnership  has no employees  and is  dependent  on the  Managing  General
Partner  and  its  affiliates  for  the  management  and  administration  of all
Partnership  activities.  The  Partnership  Agreement  provides  for (i) certain
payments to affiliates for services and (ii)  reimbursement  of certain expenses
incurred by affiliates on behalf of the Partnership. The following payments were
paid or accrued to the Managing  General Partner and affiliates  during the nine
months ended September 30, 2001 and 2000:

                                                         2001       2000
                                                          (in thousands)
         Property management fees (included in
           operating expenses)                           $229       $232
         Reimbursement for services of affiliates
           (included in general and administrative
            expenses and investment properties)           285        139

Affiliates of the Managing  General  Partner are entitled to receive 5% of gross
receipts  from both of the  Registrant's  investment  properties  for  providing
property   management   services.   The  Registrant   paid  to  such  affiliates
approximately $229,000 and $232,000 for the nine months ended September 30, 2001
and 2000, respectively.

An  affiliate  of  the  Managing  General  Partner  received   reimbursement  of
accountable  administrative  expenses  amounting to  approximately  $285,000 and
$139,000 for the nine months ended  September  30, 2001 and 2000,  respectively.
Included  in  these  amounts  at  September  30,  2001  are   reimbursements  of
approximately  $153,000 for construction oversight costs. At September 30, 2001,
approximately  $89,000  of  reimbursements  for  services  was  accrued  by  the
Partnership   and  is  included  in  due  to  affiliates  on  the   accompanying
consolidated balance sheet.

During the nine months ended  September  30, 2001 and 2000,  an affiliate of the
Managing  General Partner  advanced the Partnership  approximately  $156,000 and
$73,000,  respectively, to cover property improvements and replacements at Salem
Courthouse and Plainview.  These loans were made in accordance with the terms of
the Partnership  Agreement.  At September 30, 2001, the balance of the advances,
including accrued interest, was approximately  $128,000.  During the nine months
ended  September  30,  2001  and  2000,  the  Partnership   repaid  advances  of
approximately $68,000 and $9,000, respectively. Interest is charged at the prime
rate plus 2%. Interest  expense of  approximately  $4,000 was recognized  during
each of the nine months ended September 30, 2001 and 2000.

In addition to its indirect  ownership of the general  partner  interests in the
Partnership,  AIMCO and its affiliates  owned 382.50 limited  partnership  units
(the "Units") in the Partnership representing 37.82% of the outstanding Units at
September  30,  2001. A number of these Units were  acquired  pursuant to tender
offers  made by  AIMCO  or its  affiliates.  It is  possible  that  AIMCO or its
affiliates will make one or more additional offers to acquire additional limited
partnership  interests in the  Partnership  for cash or in exchange for units in
the operating partnership of AIMCO. Under the Partnership Agreement, unitholders
holding a majority of the Units are  entitled  to take action with  respect to a
variety of matters,  which would  include  voting on certain  amendments  to the
Partnership  Agreement and voting to remove the Managing General  Partner.  When
voting on matters, AIMCO would in all likelihood vote the Units it acquired in a
manner  favorable to the interest of the Managing General Partner because of its
affiliation with the Managing General Partner.

Note C - Casualty Gain

During  the nine  months  ended  September  30,  2001,  a net  casualty  gain of
approximately $47,000 was recorded at Salem Courthouse Apartments.  The casualty
gain related to a fire in the maintenance facility. The gain was a result of the
receipt of insurance  proceeds of approximately  $68,000 offset by approximately
$21,000 of undepreciated  property  improvements and replacements  being written
off.

Note D - Legal Proceedings

In March 1998, several putative unit holders of limited partnership units of the
Partnership  commenced an action  entitled  Rosalie  Nuanes,  et al. v. Insignia
Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the
State of  California  for the  County  of San  Mateo.  The  plaintiffs  named as
defendants,  among others,  the  Partnership,  its Managing  General Partner and
several of their  affiliated  partnerships  and corporate  entities.  The action
purports  to  assert  claims  on  behalf  of a class  of  limited  partners  and
derivatively  on behalf  of a number  of  limited  partnerships  (including  the
Partnership)  which are named as nominal  defendants,  challenging,  among other
things,  the  acquisition of interests in certain  general  partner  entities by
Insignia  Financial  Group,  Inc.  ("Insignia")  and entities which were, at one
time,  affiliates of Insignia;  past tender offers by the Insignia affiliates to
acquire  limited  partnership  units;  management  of  the  partnerships  by the
Insignia  affiliates;  and the series of transactions which closed on October 1,
1998 and  February 26, 1999 whereby  Insignia  and  Insignia  Properties  Trust,
respectively,  were merged into AIMCO.  The plaintiffs seek monetary damages and
equitable relief, including judicial dissolution of the Partnership. On June 25,
1998,  the Managing  General  Partner  filed a motion  seeking  dismissal of the
action.  In lieu of responding to the motion,  the  plaintiffs  filed an amended
complaint. The Managing General Partner filed demurrers to the amended complaint
which were heard February 1999.

Pending the ruling on such  demurrers,  settlement  negotiations  commenced.  On
November 2, 1999,  the parties  executed and filed a Stipulation  of Settlement,
settling claims, subject to court approval, on behalf of the Partnership and all
limited partners who owned units as of November 3, 1999. Preliminary approval of
the  settlement  was obtained on November 3, 1999 from the Court,  at which time
the Court set a final  approval  hearing for  December  10,  1999.  Prior to the
December  10,  1999  hearing,  the  Court  received  various  objections  to the
settlement, including a challenge to the Court's preliminary approval based upon
the alleged lack of authority of prior lead counsel to enter the settlement.  On
December 14, 1999, the Managing  General  Partner and its affiliates  terminated
the  proposed  settlement.  In  February  2000,  counsel  for some of the  named
plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who
negotiated  the  settlement.  On June  27,  2000,  the  Court  entered  an order
disqualifying  them  from the case and an  appeal  was  taken  from the order on
October 5, 2000. On December 4, 2000, the Court  appointed the law firm of Lieff
Cabraser  Heimann & Bernstein  LLP as new lead  counsel for  plaintiffs  and the
putative class.  Plaintiffs filed a third amended complaint on January 19, 2001.
On March 2, 2001,  the  Managing  General  Partner  and its  affiliates  filed a
demurrer to the third amended  complaint.  On May 14, 2001,  the Court heard the
demurrer to the third amended  complaint.  On July 10, 2001, the Court issued an
order  sustaining  defendants'  demurrer on certain  grounds.  On July 20, 2001,
plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order
granting in part and denying in part defendants' demurrer. On September 7, 2001,
plaintiffs  filed a fourth amended class and  derivative  action  complaint.  On
September 12, 2001, the Court denied plaintiffs' motion for reconsideration.  On
October 5, 2001, the Managing General Partner and affiliated  defendants filed a
demurrer to the fourth amended complaint,  which, together with a demurrer filed
by other  defendants,  is currently  scheduled to be heard on November 15, 2001.
The Court has set the matter for trial in January 2003.

During the third  quarter of 2001, a complaint  (the "Heller  action") was filed
against  the same  defendants  that are named in the  Nuanes  action,  captioned
Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed
a first amended  complaint.  The first amended complaint in the Heller action is
brought as a purported  derivative  action,  and asserts  claims for among other
things  breach  of  fiduciary  duty;  unfair  competition;   conversion,  unjust
enrichment;  and judicial  dissolution.  Plaintiffs in the Nuanes action filed a
motion to  consolidate  the Heller action with the Nuanes action and stated that
the Heller action was filed in order to preserve the derivative claims that were
dismissed  without  leave to amend in the Nuanes action by the Court order dated
July 10, 2001. On October 5, 2001, the Managing  General  Partner and affiliated
defendants  moved to strike the first  amended  complaint  in its  entirety  for
violating  the Court's July 10, 2001 order  granting in part and denying in part
defendants'  demurrer in the Nuanes action, or alternatively,  to strike certain
portions of the complaint based on the statute of limitations.  Other defendants
in the action  demurred to the fourth  amended  complaint,  and,  alternatively,
moved to strike the complaint.  The matters are currently  scheduled to be heard
on November 15, 2001.

The Managing  General Partner does not anticipate that any costs,  whether legal
or  settlement  costs,  associated  with  these  cases will be  material  to the
Partnership's overall operations.

The  Partnership is unaware of any other pending or outstanding  litigation that
is not of a routine nature arising in the ordinary course of business.


ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATIONS

The  matters  discussed  in this Form  10-QSB  contain  certain  forward-looking
statements  and  involve  risks and  uncertainties  (including  changing  market
conditions,   competitive  and  regulatory   matters,   etc.)  detailed  in  the
disclosures  contained  in this  Form  10-QSB  and the  other  filings  with the
Securities and Exchange Commission made by the Registrant from time to time. The
discussion of the  Registrant's  business and results of  operations,  including
forward-looking  statements  pertaining  to such  matters,  does not  take  into
account the effects of any changes to the  Registrant's  business and results of
operation.  Accordingly,  actual  results  could  differ  materially  from those
projected in the forward-looking  statements as a result of a number of factors,
including those identified herein.

The Partnership's  investment properties consist of two apartment complexes. The
following  table sets forth the average  occupancy of these  properties  for the
nine months ended September 30, 2001 and 2000:

                                                 Average Occupancy
                                                 2001        2000
         Salem Courthouse
            Indianapolis, Indiana                 93%         93%
         Plainview Apartments
            Louisville, Kentucky                  81%         96%

Occupancy at Plainview Apartments has decreased due to a softening market and an
increase in competition  from newer  properties in the local market.  Management
plans to aggressively pursue new tenants and work to retain its current tenants.
This could  result in the use of rental  concessions  and rental  reductions  in
addition to increased capital  expenditures and targeted advertising which could
negatively  impact the property's and the  Partnership's  short-term  cash flow.
However, management fees that these strategies will result in a return to normal
occupancy and cash flow levels in the long-term.

Results of Operations

The  Registrant's  net loss for the nine  months  ended  September  30, 2001 was
approximately $1,071,000 as compared to a net loss of approximately $353,000 for
the same period in 2000.  The  increase  in net loss for the nine  months  ended
September 30, 2001 is primarily attributable to a decrease in total revenues and
an  increase  in total  expenses.  The  decrease  in total  revenues is due to a
decrease in rental income  partially offset by an increase in other income and a
casualty gain at Salem Courthouse Apartments.  Rental income decreased primarily
due to the decrease in occupancy at Plainview  Apartments  offset by an increase
in average  rental rates at both of the investment  properties.  The increase in
other income is primarily due to an increase in utility  reimbursements and late
charges at both of the investment properties.

During  the nine  months  ended  September  30,  2001,  a net  casualty  gain of
approximately $47,000 was recorded at Salem Courthouse Apartments.  The casualty
gain related to a fire in the maintenance facility. The gain was a result of the
receipt of insurance  proceeds of approximately  $68,000 offset by approximately
$21,000 of undepreciated  property  improvements and replacements  being written
off.

The increase in total expenses is due to an increase in operating,  depreciation
and  property  tax  expenses.  The  increase in  operating  expense is due to an
increase  in  maintenance  and  repair  expense  at  Plainview   Apartments  and
utilities,  especially natural gas and water. Depreciation expense increased due
to property  improvements  and  replacements  placed in service  during the last
twelve months at both  properties  now being  depreciated.  Property tax expense
increased  due to an  increase  in the tax rates  charged  by the  local  taxing
authorities and due to the receipt of a property tax refund at Salem  Courthouse
in 2000.

The  Registrant's  net loss for the three  months ended  September  30, 2001 was
approximately  $457,000 compared to a net loss of approximately $161,000 for the
same period in 2000. The increase in net loss was  attributable to a decrease in
total revenues and an increase in total expenses. The decrease in total revenues
is due to a decrease in rental and other income  partially  offset by a casualty
gain at Salem Courthouse  Apartments.  Rental income decreased  primarily due to
the  decrease in  occupancy  at  Plainview  Apartments  offset by an increase in
average rental rates at both of the investment properties. The decrease in other
income is due to a decrease in utility reimbursements at Plainview Apartments.

The increase in total expenses for the three months ended September 30, 2001 was
due to an increase in operating and depreciation expense offset by a decrease in
general and administrative  expense. The increase in operating expense is due to
an increase in utilities, especially natural gas and water. Depreciation expense
increased due to property  improvements and replacements  during the last twelve
months at both properties now being depreciated.

General   and   administrative   expenses   decreased   due  to  a  decrease  in
reimbursements  to the Managing  General  Partner  allowed under the Partnership
Agreement associated with its management of the Partnership.  In addition, costs
associated  with the  quarterly  and annual  communications  with  investors and
regulatory  agencies and the annual audit required by the Partnership  Agreement
are also included in general and administrative expenses.

As part of the ongoing  business plan of the  Partnership,  the Managing General
Partner monitors the rental market  environment of its investment  properties to
assess the feasibility of increasing rents,  maintaining or increasing occupancy
levels and protecting  the  Partnership  from increases in expenses.  As part of
this plan, the Managing General Partner attempts to protect the Partnership from
the burden of  inflation-related  increases in expenses by increasing  rents and
maintaining a high overall  occupancy  level.  However,  due to changing  market
conditions,  which  can  result  in the use of  rental  concessions  and  rental
reductions to offset softening market conditions, there is no guarantee that the
Managing General Partner will be able to sustain such a plan.

Liquidity and Capital Resources

At  September  30,  2001,  the  Registrant  had  cash and  cash  equivalents  of
approximately $195,000 compared to approximately $699,000 at September 30, 2000.
Cash and cash equivalents  decreased  approximately  $264,000 since December 31,
2000 due to  approximately  $830,000 and $23,000 of cash used in  investing  and
financing activities,  respectively, which was partially offset by approximately
$589,000  of cash  provided  by  operating  activities.  Cash used in  investing
activities consisted of property  improvements and replacements and, to a lesser
extent,  net  deposits to escrow  accounts  maintained  by the  mortgage  lender
partially  offset by  insurance  proceeds  from a casualty  at Salem  Courthouse
Apartments.  Cash used in financing  activities  consisted of principal payments
made on the mortgages encumbering Salem Courthouse and the repayment of advances
from the Managing General Partner offset partially by advances from the Managing
General Partner. The Registrant invests its working capital reserves in interest
bearing accounts.

The sufficiency of existing  liquid assets to meet future  liquidity and capital
expenditure   requirements   is  directly   related  to  the  level  of  capital
expenditures  required at the  properties  to  adequately  maintain the physical
assets and other  operating  needs of the Registrant and to comply with Federal,
state, and local legal and regulatory requirements. Capital improvements planned
for both of the Registrant's properties are detailed below.

Plainview  Apartments:  The  Partnership  budgeted  approximately  $410,000  for
capital improvements during 2001 at Plainview Apartments consisting primarily of
interior  and  exterior  building   improvements.   The  Partnership   completed
approximately  $294,000 in capital  expenditures at Plainview  Apartments during
the nine months ended  September 30, 2001,  consisting  primarily of heating and
air  conditioning  upgrades,  floor covering,  water heater and plumbing fixture
replacements,  major landscaping and structural improvements. These improvements
were funded from operating cash flow. Additional  improvements may be considered
and will depend on the physical condition of the property as well as anticipated
cash flow generated by the property.

Salem Courthouse Apartments: The Partnership budgeted approximately $252,000 for
capital  improvements  during 2001 at Salem Courthouse  consisting  primarily of
interior  and  exterior  building   improvements.   The  Partnership   completed
approximately  $356,000 in budgeted and  non-budgeted  capital  expenditures  at
Salem  Courthouse  Apartments  during the nine months ended  September 30, 2001,
consisting primarily of exterior building painting,  floor covering replacements
and structural improvements.  These improvements were funded from operating cash
flow, replacement reserves, and insurance proceeds.  Additional improvements may
be considered and will depend on the physical  condition of the property as well
as replacement reserves and anticipated cash flow generated by the property.

The additional  capital  expenditures will be incurred only if cash is available
from operations or from Partnership  reserves.  To the extent that such budgeted
capital improvements are completed, the Registrant's distributable cash flow, if
any, may be adversely affected at least in the short term.

The  Registrant's  current assets are thought to be sufficient for any near-term
needs  (exclusive  of capital  improvements)  of the  Registrant.  The  mortgage
indebtedness of approximately  $8,080,000,  net of discount, at Salem Courthouse
is being  amortized  over 344 months  with a balloon  payment  of  approximately
$7,784,000  due  in  October  2003.  The  mortgage   indebtedness  at  Plainview
Apartments  of  approximately  $15,336,000  has interest  only payments with the
principal due in November  2010.  The Managing  General  Partner will attempt to
refinance such  indebtedness  and/or sell the properties  prior to such maturity
dates. If the properties  cannot be refinanced or sold for a sufficient  amount,
the Registrant will risk losing such properties through foreclosure.

The Partnership did not make any  distributions  to its partners during the nine
month periods ended September 30, 2001 or 2000. Future cash  distributions  will
depend on the levels of net cash generated from operations,  the availability of
cash  reserves,  and the  timing  of the debt  maturities,  refinancings  and/or
property sales. The Partnership's  distribution  policy is reviewed on a monthly
basis.  There can be no assurance that the Registrant  will generate  sufficient
funds from operations after planned capital expenditures to permit distributions
to  its  partners   during  the  remainder  of  2001  or   subsequent   periods.
Distributions  may be  restricted by the  requirements  to deposit net operating
income (as  defined in the  mortgage  note) into the reserve  account  until the
reserve  account is funded in an amount equal to a minimum of $200 and a maximum
of $400  per  apartment  unit for  Salem  Courthouse  Apartments  for a total of
approximately $78,000 to $155,000.  The reserve account balance at September 30,
2001 was approximately $87,000.

In addition to its  indirect  ownership of the general  partner  interest in the
Partnership,  AIMCO and its affiliates  owned 382.50 limited  partnership  units
(the "Units") in the Partnership representing 37.82% of the outstanding Units at
September  30,  2001. A number of these Units were  acquired  pursuant to tender
offers  made by  AIMCO  or its  affiliates.  It is  possible  that  AIMCO or its
affiliates will make one or more additional offers to acquire additional limited
partnership  interests in the  Partnership  for cash or in exchange for units in
the operating partnership of AIMCO. Under the Partnership Agreement, unitholders
holding a majority of the Units are  entitled  to take action with  respect to a
variety of matters,  which would  include  voting on certain  amendments  to the
Partnership  Agreement and voting to remove the Managing General  Partner.  When
voting on matters, AIMCO would in all likelihood vote the Units it acquired in a
manner  favorable to the interest of the Managing General Partner because of its
affiliation with the Managing General Partner.

<PAGE>

                           PART II - OTHER INFORMATION

ITEM 1.     LEGAL PROCEEDINGS

In March 1998, several putative unit holders of limited partnership units of the
Partnership  commenced an action  entitled  Rosalie  Nuanes,  et al. v. Insignia
Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the
State of  California  for the  County  of San  Mateo.  The  plaintiffs  named as
defendants,  among others,  the  Partnership,  its Managing  General Partner and
several of their  affiliated  partnerships  and corporate  entities.  The action
purports  to  assert  claims  on  behalf  of a class  of  limited  partners  and
derivatively  on behalf  of a number  of  limited  partnerships  (including  the
Partnership)  which are named as nominal  defendants,  challenging,  among other
things,  the  acquisition of interests in certain  general  partner  entities by
Insignia  Financial  Group,  Inc.  ("Insignia")  and entities which were, at one
time,  affiliates of Insignia;  past tender offers by the Insignia affiliates to
acquire  limited  partnership  units;  management  of  the  partnerships  by the
Insignia  affiliates;  and the series of transactions which closed on October 1,
1998 and  February 26, 1999 whereby  Insignia  and  Insignia  Properties  Trust,
respectively,  were merged into AIMCO.  The plaintiffs seek monetary damages and
equitable relief, including judicial dissolution of the Partnership. On June 25,
1998,  the Managing  General  Partner  filed a motion  seeking  dismissal of the
action.  In lieu of responding to the motion,  the  plaintiffs  filed an amended
complaint. The Managing General Partner filed demurrers to the amended complaint
which were heard February 1999.

Pending the ruling on such  demurrers,  settlement  negotiations  commenced.  On
November 2, 1999,  the parties  executed and filed a Stipulation  of Settlement,
settling claims, subject to court approval, on behalf of the Partnership and all
limited partners who owned units as of November 3, 1999. Preliminary approval of
the  settlement  was obtained on November 3, 1999 from the Court,  at which time
the Court set a final  approval  hearing for  December  10,  1999.  Prior to the
December  10,  1999  hearing,  the  Court  received  various  objections  to the
settlement, including a challenge to the Court's preliminary approval based upon
the alleged lack of authority of prior lead counsel to enter the settlement.  On
December 14, 1999, the Managing  General  Partner and its affiliates  terminated
the  proposed  settlement.  In  February  2000,  counsel  for some of the  named
plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who
negotiated  the  settlement.  On June  27,  2000,  the  Court  entered  an order
disqualifying  them  from the case and an  appeal  was  taken  from the order on
October 5, 2000. On December 4, 2000, the Court  appointed the law firm of Lieff
Cabraser  Heimann & Bernstein  LLP as new lead  counsel for  plaintiffs  and the
putative class.  Plaintiffs filed a third amended complaint on January 19, 2001.
On March 2, 2001,  the  Managing  General  Partner  and its  affiliates  filed a
demurrer to the third amended  complaint.  On May 14, 2001,  the Court heard the
demurrer to the third amended  complaint.  On July 10, 2001, the Court issued an
order  sustaining  defendants'  demurrer on certain  grounds.  On July 20, 2001,
plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order
granting in part and denying in part defendants' demurrer. On September 7, 2001,
plaintiffs  filed a fourth amended class and  derivative  action  complaint.  On
September 12, 2001, the Court denied plaintiffs' motion for reconsideration.  On
October 5, 2001, the Managing General Partner and affiliated  defendants filed a
demurrer to the fourth amended complaint,  which, together with a demurrer filed
by other  defendants,  is currently  scheduled to be heard on November 15, 2001.
The Court has set the matter for trial in January 2003.

During the third  quarter of 2001, a complaint  (the "Heller  action") was filed
against  the same  defendants  that are named in the  Nuanes  action,  captioned
Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed
a first amended  complaint.  The first amended complaint in the Heller action is
brought as a purported  derivative  action,  and asserts  claims for among other
things  breach  of  fiduciary  duty;  unfair  competition;   conversion,  unjust
enrichment;  and judicial  dissolution.  Plaintiffs in the Nuanes action filed a
motion to  consolidate  the Heller action with the Nuanes action and stated that
the Heller action was filed in order to preserve the derivative claims that were
dismissed  without  leave to amend in the Nuanes action by the Court order dated
July 10, 2001. On October 5, 2001, the Managing  General  Partner and affiliated
defendants  moved to strike the first  amended  complaint  in its  entirety  for
violating  the Court's July 10, 2001 order  granting in part and denying in part
defendants'  demurrer in the Nuanes action, or alternatively,  to strike certain
portions of the complaint based on the statute of limitations.  Other defendants
in the action  demurred to the fourth  amended  complaint,  and,  alternatively,
moved to strike the complaint.  The matters are currently  scheduled to be heard
on November 15, 2001.

The Managing  General Partner does not anticipate that any costs,  whether legal
or  settlement  costs,  associated  with  these  cases will be  material  to the
Partnership's overall operations.

ITEM 6      EXHIBITS AND REPORTS ON FORM 8-K

            a)    Exhibits

                  None.

            b)    Reports on Form 8-K:

                  None filed during the quarter ended September 30, 2001.

<PAGE>


                                   SIGNATURES



In accordance with the  requirements of the Exchange Act, the registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.



                                    DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.


                                    By:   Davidson Diversified Properties, Inc.
                                          Managing General Partner


                                    By:   /s/Patrick J. Foye
                                          Patrick J. Foye
                                          Executive Vice President


                                    By:   /s/Martha L. Long
                                          Martha L. Long
                                          Senior Vice President and
                                          Controller


                                    Date: