UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549



FORM 10-QSB



(Mark One)

[X]

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended September 30, 2006





[ ]

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT





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 ___



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ___ No _X_



PART I - FINANCIAL INFORMATION





ITEM 1.

FINANCIAL STATEMENTS







DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED BALANCE SHEET

(Unaudited)

(in thousands, except unit data)



September 30, 2006







|                                            |           |         
|------------------------------------------- | --------- | --------
|Assets                                      |           |         
|Cash and cash equivalents                   |           | $    300
|Receivables and deposits                    |           | 341     
|Other assets                                |           | 173     
|Investment property:                        |           |         
|Land                                        | $  2,047  |         
|Buildings and related personal property     | 27,239    |         
|                                            | 29,286    |         
|Less accumulated depreciation               | (17,516)  | 11,770  
|                                            |           | $12,584 
|                                            |           |         
|Liabilities and Partners' Deficit           |           |         
|Liabilities                                 |           |         
|Accounts payable                            |           | $     31
|Tenant security deposit liabilities         |           | 73      
|Accrued property taxes                      |           | 96      
|Other liabilities                           |           | 207     
|Deferred tax liability (Note D)             |           | 276     
|Due to affiliates (Note C)                  |           | 5,364   
|Mortgage note payable                       |           | 15,336  
|                                            |           |         
|Partners' Deficit                           |           |         
|General partners                            | $   (177) |         
|Limited partners (1,011.25 units issued and |           |         
|outstanding)                                | (8,622)   | (8,799) 
|                                            |           | $12,584 



See Accompanying Notes to Consolidated Financial Statements

















DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per unit data)







|                                |                    |                   |             |            
|------------------------------- | ------------------ | ----------------- | ----------- | -----------
|                                | Three Months Ended | Nine Months Ended
|                                | September 30,      | September 30,    
|                                | 2006               | 2005              | 2006        | 2005       
|Revenues:                       |                    | (Restated)        |             | (Restated) 
|Rental income                   | $    838           | $    831          | $    2,583  | $    2,451 
|Other income                    | 138                | 118               | 503         | 391        
|Total revenues                  | 976                | 949               | 3,086       | 2,842      
|                                |                    |                   |             |            
|Expenses:                       |                    |                   |             |            
|Operating                       | 453                | 416               | 1,529       | 1,415      
|General and administrative      | 36                 | 54                | 161         | 157        
|Depreciation                    | 300                | 299               | 897         | 889        
|Interest                        | 484                | 581               | 1,438       | 1,687      
|Property taxes                  | 32                 | 31                | 95          | 93         
|Deferred tax expense (Note D)   | --                 | --                | --          | 301        
|Total expenses                  | 1,305              | 1,381             | 4,120       | 4,542      
|                                |                    |                   |             |            
|Loss from continuing operations | (329)              | (432)             | (1,034)     | (1,700)    
|                                |                    |                   |             |            
|(Loss) income from discontinued |                    |                   |             |            
|operations (Note B)             | --                 | (12)              | --          | 41         
|Net loss                        | $(329)             | $(444)            | $(1,034)    | $(1,659)   
|                                |                    |                   |             |            
|Net loss allocated to general   |                    |                   |             |            
|partners (2%)                   | $     (7)          | $     (9)         | $      (21) | $      (33)
|Net loss allocated to limited   |                    |                   |             |            
|partners (98%)                  | (322)              | (435)             | (1,013)     | (1,626)    
|                                | $(329)             | $(444)            | $(1,034)    | $(1,659)   
|Per limited partnership unit:   |                    |                   |             |            
|Loss from continuing operations | $(318.42)          | $(418.19)         | $(1,001.73) | $(1,647.06)
|(Loss) income from discontinued |                    |                   |             |            
|operations                      | --                 | (11.86)           | --          | 39.55      
|Net loss                        | $(318.42)          | $(430.05)         | $(1,001.73) | $(1,607.51)



See Accompanying Notes to Consolidated Financial Statements

















DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT

(Unaudited)

(in thousands, except unit data)







|                               |             |          |           |          
|------------------------------ | ----------- | -------- | --------- | ---------
|                               | Limited     |          |           |          
|                               | Partnership | General  | Limited   |          
|                               | Units       | Partners | Partners  | Total    
|                               |             |          |           |          
|Original capital contributions | 1,013.0     | $1       | $20,240   | $20,241  
|                               |             |          |           |          
|Partners' deficit at           |             |          |           |          
|December 31, 2005              | 1,011.50    | $  (156) | $ (7,609) | $ (7,765)
|                               |             |          |           |          
|Abandonment of limited         |             |          |           |          
|partnership units (Note E)     | (.25)       | --       | --        | --       
|                               |             |          |           |          
|Net loss for the nine months   |             |          |           |          
|ended September 30, 2006       | --          | (21)     | (1,013)   | (1,034)  
|                               |             |          |           |          
|Partners' deficit at           |             |          |           |          
|September 30, 2006             | 1,011.25    | $(177)   | $(8,622)  | $(8,799) 





See Accompanying Notes to Consolidated Financial Statements













DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)









|                                                        |                   |         
|------------------------------------------------------- | ----------------- | --------
|                                                        | Nine Months Ended
|                                                        | September 30,    
|                                                        | 2006              | 2005    
|Cash flows from operating activities:                   |                   |         
|Net loss                                                | $(1,034)          | $(1,659)
|Adjustments to reconcile net loss to net cash (used in) |                   |         
|provided by operating activities:                       |                   |         
|Depreciation                                            | 897               | 1,473   
|Amortization of loan costs                              | 11                | 24      
|Bad debt expense                                        | 36                | 76      
|Change in accounts:                                     |                   |         
|Receivables and deposits                                | (19)              | (55)    
|Other assets                                            | (39)              | (64)    
|Accounts payable                                        | (107)             | (73)    
|Tenant security deposit liabilities                     | 2                 | (2)     
|Accrued property taxes                                  | 96                | 154     
|Other liabilities                                       | 8                 | 6       
|Deferred tax liability                                  | --                | 301     
|Due to affiliates                                       | (468)             | 681     
|Net cash (used in) provided by operating activities     | (617)             | 862     
|                                                        |                   |         
|Cash flows used in investing activities:                |                   |         
|Property improvements and replacements                  | (281)             | (582)   
|                                                        |                   |         
|Cash flows used in financing activities:                |                   |         
|Payments on mortgage note payable                       | --                | (99)    
|                                                        |                   |         
|Net (decrease) increase in cash and cash equivalents    | (898)             | 181     
|Cash and cash equivalents at beginning of period        | 1,198             | 226     
|                                                        |                   |         
|Cash and cash equivalents at end of period              | $300              | $407    
|                                                        |                   |         
|Supplemental disclosure of cash flow information:       |                   |         
|Cash paid for interest                                  | $1,890            | $1,228  



See Accompanying Notes to Consolidated Financial Statements

















DAVIDSON DIVERSIFIED REAL ESTATE III, L.P.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note A  Going Concern



The accompanying consolidated financial statements have been prepared assuming Davidson Diversified Real Estate III, L.P., (the Partnership or Registrant), will continue as a going concern.  The Partnership has recurring operating losses, an accumulated deficit and as of September 30, 2006 had approximately $5,364,000 of advances and accrued interest due to an affiliate of Davidson Diversified Properties, Inc. (the "Managing General Partner").  In a letter dated April 4, 2006,  this affiliate of the Managing General Partner demanded payment in full of all outstanding advances owed by the Partnership to it, plus related accrued interest.  The Partnership does not have sufficient assets to repay the advances and related accrued interest.  In addition, the Partnership does not believe that the proceeds from a refinancing of the mortgage of the Partnerships sole remaining investment property would be sufficient to repay the existing first mortgage plus the advances and related accrued interest due to an affiliate of the Managing General Partner.  If the Partnership defaults on its repayment of the advances due to an affiliate of the Managing General Partner, the Partnership will risk losing its sole investment property through foreclosure.  The Managing General Partner is evaluating its options relative to the payment demand by an affiliate of the Managing General Partner.



As a result of the above, there is substantial doubt about the Partnerships ability to continue as a going concern.  The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.



Note B - Basis of Presentation



The accompanying unaudited consolidated financial statements of the Partnership 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 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, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. 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, 2005. The Managing General Partner is a wholly owned subsidiary of Apartment Investment and Management Company ("AIMCO"), a publicly traded real estate investment trust.



In accordance with Statement of Financial Accounting Standards (SFAS) No. 144 Accounting for the Impairment or Disposal of Long-Lived Asset, the accompanying consolidated statements of operations for the three and nine months ended September 30, 2005 have been restated as of January 1, 2005 to reflect the operations of Salem Courthouse Apartments which was sold on December 1, 2005 as (loss) income from discontinued operations. Included in the (loss) income from discontinued operations for the three and nine months ended September 30, 2005 are revenues of approximately $638,000 and $1,834,000, respectively, and expenses of approximately $650,000 and $1,793,000, respectively, for Salem Courthouse for the three and nine months ended September 30, 2005.



Note C - Transactions with Affiliated Parties



The Partnership has no employees and depends 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, 2006 and 2005.



Affiliates of the Managing General Partner received 5% of gross receipts from both of the Partnership's investment properties as compensation for providing property management services. The Partnership paid to such affiliates approximately $152,000 and $230,000 for the nine months ended September 30, 2006 and 2005, respectively, which is included in operating expenses and (loss) income from discontinued operations.



Affiliates of the Managing General Partner charged the Partnership reimbursement of accountable administrative expenses amounting to approximately $94,000 and $169,000 for the nine months ended September 30, 2006 and 2005, respectively, which is included in general and administrative expenses and investment property. The portion of these reimbursements included in investment property for the nine months ended September 30, 2006 and 2005 are fees related to construction management services provided by an affiliate of the Managing General Partner of approximately $29,000 and $59,000, respectively.



During the nine months ended September 30, 2006 and 2005, no advances were made by the Managing General Partner to the Partnership. In prior years the Managing General Partner has advanced funds to the Partnership for redevelopment costs and operational expenses at the Partnerships properties. These advances were made in accordance with the terms of the Partnership Agreement. At September 30, 2006, the balance of the advances, including accrued interest, was approximately $5,364,000 and is included in due to affiliates on the accompanying consolidated balance sheet. Interest is charged at the prime rate plus 1% (9.25% at September 30, 2006). Interest expense was approximately $354,000 and $564,000 for the nine months ended September 30, 2006 and 2005, respectively. During the nine months ended September 30, 2006 the Partnership paid approximately $817,000 of accrued interest. There were no payments made during the nine months ended September 30, 2005.



During 2005, the Partnership insured Salem Courthouse up to certain limits through coverage provided by AIMCO which is generally self-insured for a portion of losses and liabilities related to workers compensation, property casualty, general liability and vehicle liability. The Partnership insured Salem Courthouse above the AIMCO limits through insurance policies obtained by AIMCO from insurers unaffiliated with the Managing General Partner. The Managing General Partner has obtained insurance coverage for Plainview Apartments for 2006 and 2005 from both AIMCO and a third party.  During the nine months ended September 30, 2006 and 2005, the Partnership was charged by AIMCO and its affiliates approximately $113,000 and $86,000, respectively, for insurance coverage and fees associated with policy claims administration.



Note D  Partnership Income Taxes



The state of Kentucky has enacted tax legislation, effective for years beginning on or after January 1, 2005, concerning income taxes that will impact the Partnership.  One of the provisions of the legislation requires the Partnership to be liable for any Kentucky income taxes that arise as a result of the Partnerships remaining property, Plainview Apartments, being located in the state of Kentucky.  During the year ended December 31, 2005, the Partnership estimated that a deferred tax liability exists of approximately $276,000 as a result of this tax legislation and accordingly recorded such liability. There was no change in this estimate for the nine months ended September 30, 2006.



Note E  Abandonment of Units



During the nine months ended September 30, 2006, the number of limited partnership units (the Units) decreased by .25 Units due to limited partners abandoning their Units. In abandoning his or her Units, a limited partner relinquishes all right, title and interest in the Partnership as of the date of abandonment. The loss per Unit on the accompanying consolidated statements of operations is calculated based on the number of Units outstanding at September 30, 2006 and 2005, which was 1,011.25 and 1,011.50, respectively.



Note F - Contingencies



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 purported to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) that are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities that 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 sought monetary damages and equitable relief, including judicial dissolution of the Partnership. In addition, during the third quarter of 2001, a complaint captioned Heller v. Insignia Financial Group (the "Heller action") was filed against the same defendants that are named in the Nuanes action. On or about August 6, 2001, plaintiffs filed a first amended complaint. The Heller action was brought as a purported derivative action, and asserted claims for, among other things, breach of fiduciary duty, unfair competition, conversion, unjust enrichment, and judicial dissolution. On January 28, 2002, the trial court granted defendants motion to strike the complaint.  Plaintiffs took an appeal from this order.



On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action. On June 13, 2003, the court granted final approval of the settlement and entered judgment in both the Nuanes and Heller actions. On August 12, 2003, an objector ("Objector") filed an appeal (the Appeal) seeking to vacate and/or reverse the order approving the settlement and entering judgment thereto. On May 4, 2004, the Objector filed a second appeal challenging the courts use of a referee and its order requiring Objector to pay those fees.



On March 21, 2005, the Court of Appeals issued opinions in both pending appeals.  With regard to the settlement and judgment entered thereto, the Court of Appeals vacated the trial courts order and remanded to the trial court for further findings on the basis that the state of the record is insufficient to permit meaningful appellate review.  The matter was transferred back to the trial court on June 21, 2005.  With regard to the second appeal, the Court of Appeals reversed the order requiring the Objector to pay referee fees. With respect to the related Heller appeal, on July 28, 2005, the Court of Appeals reversed the trial courts order striking the first amended complaint.



On August 18, 2005, Objector and his counsel filed a motion to disqualify the trial court based on a peremptory challenge and filed a motion to disqualify for cause on October 17, 2005, both of which were ultimately denied and/or struck by the trial court.  On or about October 13, 2005 Objector filed a motion to intervene and on or about October 19, 2005 filed both a motion to take discovery relating to the adequacy of plaintiffs as derivative representatives and a motion to dissolve the anti-suit injunction in connection with settlement.  On November 14, 2005, Plaintiffs filed a Motion For Further Findings pursuant to the remand ordered by the Court of Appeals. Defendants joined in that motion.  On February 3, 2006, the Court held a hearing on the various matters pending before it and ordered additional briefing from the parties and Objector. On June 30, 2006, the trial court entered an order confirming its approval of the class action settlement and entering judgment thereto after the Court of Appeals had remanded the matter for further findings.  The substantive terms of the settlement agreement remain unchanged.  The trial court also entered supplemental orders on July 1, 2006, denying Objectors Motion to File a Complaint in Intervention, Objectors Motion for Leave of Discovery and Objectors Motion to Dissolve the Anti-Suit Injunction.  Notice of Entry of Judgment was served on July 10, 2006. On August 31, 2006, the Objector filed a Notice of Appeal to the Courts June 30, 2006 and July 1, 2006 orders.



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



AIMCO Properties L.P. and NHP Management Company, both affiliates of the ManagingGeneral Partner, are defendants in a lawsuit alleging that they willfully violated the Fair Labor Standards Act (FLSA) by failing to pay maintenance workers overtime for all hours worked in excess of forty per week. The complaint, filed in the United States District Court for the District of Columbia, attempts to bring a collective action under the FLSA and seeks to certify state subclasses in California, Maryland, and the District of Columbia. Specifically, the plaintiffs contend that AIMCO Properties L.P. and NHP Management Company failed to compensate maintenance workers for time that they were required to be "on-call." Additionally, the complaint alleges AIMCO Properties L.P. and NHP Management Company failed to comply with the FLSA in compensating maintenance workers for time that they worked in excess of 40 hours in a week.   In June 2005 the court conditionally certified the collective action on both the on-call and overtime issues.  Approximately 1,049 individuals opted in to the class. The defendants moved to decertify the collective action on both issues and the plaintiffs have responded.  Because the court denied plaintiffs motion to certify state subclasses, in September 2005, the plaintiffs filed a class action with the same allegations in the Superior Court of California (Contra Costa County), and in November 2005 in Montgomery County Maryland Circuit Court.  The California and Maryland cases have been stayed pending the outcome of the decertification motion in the District of Columbia case.  Although the outcome of any litigation is uncertain, AIMCO Properties, L.P. does not believe that the ultimate outcome will have a material adverse effect on its consolidated financial condition or results of operations. Similarly, the Managing General Partner does
not believe that the ultimate outcome will have a material adverse effect on the Partnerships consolidated financial condition or results of operations.



The Partnership is unaware of any other pending or outstanding litigation matters involving it or its investment property that are not of a routine nature arising in the ordinary course of business.



Environmental



Various Federal, state and local laws subject property owners or operators to liability for management, and the costs of removal or remediation, of certain hazardous substances present on a property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of the hazardous substances. The presence of, or the failure to manage or remedy properly, hazardous substances may adversely affect occupancy at affected apartment communities and the ability to sell or finance affected properties. In addition to the costs associated with investigation and remediation actions brought by government agencies, and potential fines or penalties imposed by such agencies in connection therewith, the presence of hazardous substances on a property could result in claims by private plaintiffs for personal injury, disease, disability or other infirmities. Various laws also impose liability for the cost of removal, remediation or disposal of hazardous substances through a licensed disposal or treatment facility. Anyone who arranges for the disposal or treatment of hazardous substances is potentially liable under such laws. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. In connection with the ownership, operation and management of its property, the Partnership could potentially be liable for environmental liabilities or costs associated with its property.



Mold



The Partnership is aware of lawsuits against owners and managers of multifamily properties asserting claims of personal injury and property damage caused by the presence of mold, some of which have resulted in substantial monetary judgments or settlements.  The Partnership has only limited insurance coverage for property damage loss claims arising from the presence of mold and for personal injury claims related to mold exposure.  Affiliates of the Managing General Partner have implemented a national policy and procedures to prevent or eliminate mold from its properties and the Managing General Partner believes that these measures will minimize the effects that mold could have on residents.  During 2003, the Partnership completed a rehabilitation project at Plainview Apartments which cost approximately $5,300,000. Part of the rehabilitation project was to address mold abatement conditions with the rest relating to general updating of the property. Because the law regarding mold is unsettled and subject to change the Managing General Partner can make no assurance that liabilities resulting from the presence of or exposure to mold will not have a material adverse effect on the Partnerships consolidated financial condition or results of operations.





ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATION



The matters discussed in this report contain certain forward-looking statements, including, without limitation, statements regarding future financial performance and the effect of government regulations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors including, without limitation: national and local economic conditions; the terms of governmental regulations that affect the Registrant and interpretations of those regulations; the competitive environment in which the Registrant operates; financing risks, including the risk that cash flows from operations may be insufficient to meet required payments of principal and interest; real estate risks, including variations of real estate values and the general economic climate in local markets and competition for tenants in such markets; litigation, including costs associated with prosecuting and defending claims and any adverse outcomes, and possible environmental liabilities. Readers should carefully review the Registrant's financial statements and the notes thereto, as well as the risk factors described in the documents the Registrant files from time to time with the Securities and Exchange Commission.



The Partnerships remaining investment property consists of one apartment complex, Plainview Apartments, located in Louisville, Kentucky.  The average occupancy of the property for the nine months ended September 30, 2006 and 2005 was 96% and 95%, respectively.



The Partnerships financial results depend upon a number of factors including the ability to attract and maintain tenants at the investment property, interest rates on mortgage loans, costs incurred to operate the investment property, general economic conditions and weather. As part of the ongoing business plan of the Partnership, the Managing General Partner monitors the rental market environment of its investment property 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, the Managing General Partner may use rental concessions and rental rate reductions to offset softening market conditions, accordingly, there is no guarantee that the Managing General Partner will be able to sustain such a plan. Further, a number of factors that are outside the control of the Partnership such as the local economic climate and weather can adversely or positively affect the Partnerships financial results.



Results of Operations



The Partnership recognized a net loss of approximately $329,000 and $1,034,000 for the three and nine months ended September 30, 2006, respectively, compared to a net loss of approximately $444,000 and $1,659,000 for the three and nine months ended September 30, 2005, respectively. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144 Accounting for the Impairment or Disposal of Long-Lived Asset, the consolidated statements of operations for the three and nine month periods ended September 30, 2005 have been restated to reflect the operations of Salem Courthouse Apartments as (loss) income from discontinued operations due to the sale of the property in December 2005.  For the three and nine months ended September 30, 2005, Salem Courthouse Apartments had revenues of approximately $638,000 and $1,834,000, respectively, offset by expenses of approximately $650,000 and $1,793,000, respectively.



Excluding the (loss) income from discontinued operations, the Partnerships loss from continuing operations for the three and nine months ended September 30, 2006 was approximately $329,000 and $1,034,000 compared to losses from continuing
operations of approximately $432,000 and $1,700,000 for the three and nine months ended September 30, 2005, respectively. The decrease in net loss from continuing operations for both the three and nine months ended September 30, 2006 is due to a decrease in total expenses and an increase in total revenues. Total revenues for both the three and nine months ended September 30, 2006 increased due to increases in both rental and other income.  Rental income increased due to an increase in occupancy and the average rental rate at Plainview Apartments and a decrease in bad debt expense.  Other income increased due to an increase in resident utility payments at Plainview Apartments and increased interest income at the Partnership due to higher cash balances from the sale of Salem Courthouse Apartments in December 2005.



Total expenses decreased for the three months ended September 30, 2006 due to decreases in interest and general and administrative expenses.  Total expenses decreased for the nine months ended September 30, 2006 due to decreases in deferred tax expense and interest expense. Operating expense increased for both the three and nine months ended September 30, 2006.  Depreciation and property tax expenses remained relatively constant for both periods while general and administrative expense remained relatively constant for the nine months ended September 30, 2006.



Interest expense decreased for both the three and nine months ended September 30, 2006 due to a decrease in interest charged on advances from affiliates as a result of a decrease in the outstanding balance on the advances from affiliates of the Managing General Partner.



Operating expense increased for both the three and nine months ended September 30, 2006 due to an increase in property expense partially offset by a decrease in maintenance expense for both periods and a decrease in administrative expense for the three months ended September 30, 2006. Property expense increased for the three months ended September 30, 2006 due to an increase in salaries and related employee benefits offset by a decrease in utility expense at Plainview Apartments.  Property expense increased for the nine months ended September 30, 2006 due to an increase in utility expense and salaries and related employee benefits at Plainview Apartments.  Maintenance expense decreased for both periods due to a decrease in contract services at Plainview Apartments.  Administrative expense decreased due to decreased phone sales and supplies at Plainview Apartments.



The decrease in deferred tax expense for the nine months ended September 30, 2006 is due to tax legislation enacted by the state of Kentucky which is effective for tax years beginning on or after January 1, 2005 concerning income taxes that impact the Partnership.  One of the provisions of the legislation requires the Partnership to be liable for any Kentucky income taxes that arise as a result of the Partnerships remaining property, Plainview Apartments, being located in the state of Kentucky.  During the second quarter of 2005, the Partnership estimated that a deferred tax liability exists of approximately $301,000 as a result of this legislation and accordingly recorded such liability.  During the fourth quarter of 2005 the Partnership revised this estimate and recorded a reduction in the liability of approximately $25,000.  There was no change in this estimate for the nine months ended September 30, 2006.



General and administrative expenses decreased for the three month period ended September 30, 2006 due to a decrease in reimbursements to the Managing General Partner allowed under the Partnership Agreement associated with the management of the Partnership. General and administrative expense remained relatively constant for the nine months ended September 30, 2006 as an increase in legal fees was offset by a decrease in reimbursements to the Managing General Partner. The decrease in reimbursements for both periods is due to the sale of Salem Courthouse Apartments in December 2005.  The increase in legal fees is a result of the demand notice received by the Partnership related to the advances and accrued interest
owed to an affiliate of the Managing General Partner. 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.



Liquidity and Capital Resources



At September 30, 2006, the Partnership had cash and cash equivalents of approximately $300,000 compared to approximately $407,000 at September 30, 2005. The decrease in cash and cash equivalents of approximately $898,000 from December 31, 2005 is due to approximately $617,000 and $281,000 of cash used in operating and investing activities, respectively.  Cash used in investing activities consisted of property improvements and replacements. The Partnership invests its working capital 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 property to adequately maintain the physical assets and other operating needs of the Partnership and to comply with Federal, state, and local legal and regulatory requirements. The Managing General Partner monitors developments in the area of legal and regulatory compliance.  For example, the Sarbanes-Oxley Act of 2002 mandates or suggests additional compliance measures with regard to governance, disclosure, audit and other areas. In light of these changes, the Partnership expects that it will incur higher expenses related to compliance. Capital improvements planned for the Partnership's remaining property are detailed below.



Plainview Apartments: During the nine months ended September 30, 2006, the Partnership completed approximately $281,000 in capital expenditures at Plainview Apartments consisting of concrete work, foundation water proofing and roof and floor covering replacements. These expenditures were funded from operating cash flow.  The Partnership regularly evaluates the capital improvement needs of the property. While the Partnership has no material commitments for property improvements and replacements, certain routine capital expenditures are anticipated during 2006. Such capital expenditures will depend on the physical condition of the property as well as 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 capital improvements are completed, the Partnership's distributable cash flow, if any, may be adversely affected at least in the short term.



The Partnerships assets are thought to be generally sufficient for any near-term needs (exclusive of capital improvements) of the Partnership.  The mortgage indebtedness encumbering Plainview Apartments of approximately $15,336,000 requires monthly payments of interest only with a balloon payment of approximately $15,336,000 due November 15, 2010. The Managing General Partner will attempt to refinance such indebtedness and/or sell the property prior to maturity. If the property cannot be refinanced or sold for a sufficient amount, the Partnership will risk losing the property through foreclosure.



There were no distributions to the partners during the nine months ended September 30, 2006 and 2005. Future cash distributions will depend on the levels of net cash generated from operations, the timing of debt maturity, property sale and/or refinancing. The Partnership's cash available for distribution is reviewed on a monthly basis. In light of the amounts accrued and payable to an affiliate of the Managing General Partner at September 30, 2006, there can be no assurance that the Partnership will generate sufficient funds from operations, after capital
expenditures, to permit any distributions to its partners during 2006 or subsequent periods.



Other



In addition to its indirect ownership of the managing general partner interest in the Partnership, AIMCO and its affiliates owned 440.50 limited partnership units (the Units) in the Partnership representing 43.56% of the outstanding Units at September 30, 2006. 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 acquire additional Units in exchange for cash or a combination of cash and units in AIMCO Properties, L.P., the operating partnership of AIMCO, either through private purchases or tender offers. Pursuant to the Partnership Agreement, unitholders holding a majority of the Units are entitled to take action with respect to a variety of matters that include, but are not limited to, voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner.  As a result of its ownership of 43.56% of the outstanding Units, AIMCO and its affiliates are in a position to influence all such voting decisions with respect to the Partnership. Although the Managing General Partner owes fiduciary duties to the limited partners of the Partnership, the Managing General Partner also owes fiduciary duties to AIMCO as its sole stockholder. As a result, the duties of the Managing General Partner, as managing general partner, to the Partnership and its limited partners may come into conflict with the duties of the Managing General Partner to AIMCO as its sole stockholder.



Critical Accounting Policies



The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States which require the Partnership to make estimates and assumptions. The Partnership believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity.



Impairment of Long-Lived Asset



Investment property is recorded at cost, less accumulated depreciation, unless the carrying amount of the asset is not recoverable.  If events or circumstances indicate that the carrying amount of the property may not be recoverable, the Partnership will make an assessment of its recoverability by comparing the carrying amount to the Partnerships estimate of the undiscounted future cash flows, excluding interest charges, of the property.   If the carrying amount exceeds the aggregate undiscounted future cash flows, the Partnership would recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property.



Real property investment is subject to varying degrees of risk.  Several factors may adversely affect the economic performance and value of the Partnerships investment property.  These factors include, but are not limited to, general economic climate; competition from other apartment communities and other housing options; local conditions, such as loss of jobs or an increase in the supply of apartments that might adversely affect apartment occupancy or rental rates; changes in governmental regulations and the related cost of compliance; increases in operating costs (including real estate taxes) due to inflation and other factors, which may not be offset by increased rents; and changes in tax laws and housing laws, including the enactment of rent control laws or other laws regulating multi-family housing.  Any adverse changes in these factors could cause impairment of the Partnerships asset.



Revenue Recognition



The Partnership generally leases apartment units for twelve-month terms or less.  The Partnership will offer rental concessions during particularly slow months or in response to heavy competition from other similar complexes in the area.  Rental income attributable to leases, net of any concessions, is recognized on a straight-line basis over the term of the lease.  The Partnership evaluates all accounts receivable from residents and establishes an allowance, after the application of security deposits, for accounts greater than 30 days past due on current tenants and all receivables due from former tenants.



ITEM 3.

CONTROLS AND PROCEDURES



(a)

Disclosure Controls and Procedures. The Partnerships management, with the participation of the principal executive officer and principal financial officer of the Managing General Partner, who are the equivalent of the Partnerships principal executive officer and principal financial officer, respectively, has evaluated the effectiveness of the Partnerships disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, the principal executive officer and principal financial officer of the Managing General Partner, who are the equivalent of the Partnerships principal executive officer and principal financial officer, respectively, have concluded that, as of the end of such period, the Partnerships disclosure controls and procedures are effective.



(b)

Internal Control Over Financial Reporting. There have not been any changes in the Partnerships internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Partnerships internal control over financial reporting.



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 purported to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) that are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities that 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 sought monetary damages and equitable relief, including judicial dissolution of the Partnership. In addition, during the third quarter of 2001, a complaint captioned Heller v. Insignia Financial Group (the "Heller action") was filed against the same defendants that are named in the Nuanes action. On or about August 6, 2001, plaintiffs filed a first amended complaint. The Heller action was brought as a purported derivative action, and asserted claims for, among other things, breach of fiduciary duty, unfair competition, conversion, unjust enrichment, and judicial dissolution. On January 28, 2002, the trial court granted defendants motion to strike the complaint.  Plaintiffs took an appeal from this order.



On January 8, 2003, the parties filed a Stipulation of Settlement in proposed settlement of the Nuanes action and the Heller action. On June 13, 2003, the court granted final approval of the settlement and entered judgment in both the Nuanes and Heller actions. On August 12, 2003, an objector ("Objector") filed an appeal (the Appeal) seeking to vacate and/or reverse the order approving the settlement and entering judgment thereto. On May 4, 2004, the Objector filed a second appeal challenging the courts use of a referee and its order requiring Objector to pay those fees.



On March 21, 2005, the Court of Appeals issued opinions in both pending appeals.  With regard to the settlement and judgment entered thereto, the Court of Appeals vacated the trial courts order and remanded to the trial court for further findings on the basis that the state of the record is insufficient to permit meaningful appellate review.  The matter was transferred back to the trial court on June 21, 2005.  With regard to the second appeal, the Court of Appeals reversed the order requiring the Objector to pay referee fees. With respect to the related Heller appeal, on July 28, 2005, the Court of Appeals reversed the trial courts order striking the first amended complaint.



On August 18, 2005, Objector and his counsel filed a motion to disqualify the trial court based on a peremptory challenge and filed a motion to disqualify for cause on October 17, 2005, both of which were ultimately denied and/or struck by the trial court.  On or about October 13, 2005 Objector filed a motion to intervene and on or about October 19, 2005 filed both a motion to take discovery relating to the adequacy of plaintiffs as derivative representatives and a motion to dissolve the anti-suit injunction in connection with settlement.  On November 14, 2005, Plaintiffs filed a Motion For Further Findings pursuant to the remand ordered by the Court of Appeals. Defendants joined in that motion.  On February 3, 2006, the Court held a hearing on the various matters pending before it and ordered
additional briefing from the parties and Objector. On June 30, 2006, the trial court entered an order confirming its approval of the class action settlement and entering judgment thereto after the Court of Appeals had remanded the matter for further findings.  The substantive terms of the settlement agreement remain unchanged.  The trial court also entered supplemental orders on July 1, 2006, denying Objectors Motion to File a Complaint in Intervention, Objectors Motion for Leave of Discovery and Objectors Motion to Dissolve the Anti-Suit Injunction.  Notice of Entry of Judgment was served on July 10, 2006. On August 31, 2006, the Objector filed a Notice of Appeal to the Courts June 30, 2006 and July 1, 2006 orders.



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



AIMCO Properties L.P. and NHP Management Company, both affiliates of the ManagingGeneral Partner, are defendants in a lawsuit alleging that they willfully violated the Fair Labor Standards Act (FLSA) by failing to pay maintenance workers overtime for all hours worked in excess of forty per week. The complaint, filed in the United States District Court for the District of Columbia, attempts to bring a collective action under the FLSA and seeks to certify state subclasses in California, Maryland, and the District of Columbia. Specifically, the plaintiffs contend that AIMCO Properties L.P. and NHP Management Company failed to compensate maintenance workers for time that they were required to be "on-call." Additionally, the complaint alleges AIMCO Properties L.P. and NHP Management Company failed to comply with the FLSA in compensating maintenance workers for time that they worked in excess of 40 hours in a week.   In June 2005 the court conditionally certified the collective action on both the on-call and overtime issues.  Approximately 1,049 individuals opted in to the class. The defendants moved to decertify the collective action on both issues and the plaintiffs have responded.  Because the court denied plaintiffs motion to certify state subclasses, in September 2005, the plaintiffs filed a class action with the same allegations in the Superior Court of California (Contra Costa County), and in November 2005 in Montgomery County Maryland Circuit Court.  The California and Maryland cases have been stayed pending the outcome of the decertification motion in the District of Columbia case.  Although the outcome of any litigation is uncertain, AIMCO Properties, L.P. does not believe that the ultimate outcome will have a material adverse effect on its consolidated financial condition or results of operations. Similarly, the Managing General Partner does not believe that the ultimate outcome will have a material adverse effect on the Partnerships consolidated financial condition or results of operations.



ITEM 5.

OTHER INFORMATION



None.



ITEM 6.

EXHIBITS



See Exhibit Index.



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                    
|                        |                                             
|Date: November 13, 2006 | By:   /s/Martha L. Long                     
|                        | Martha L. Long                              
|                        | Senior Vice President                       
|                        |                                             
|Date: November 13, 2006 | By:   /s/Stephen B. Waters                  
|                        | Stephen B. Waters                           
|                        | Vice President                              





DAVIDSON DIVERSIFIED REAL ESTATE III, LP

EXHIBIT INDEX





Exhibit Number

Description of Exhibit



3

Partnership Agreement dated July 8, 1985 and amended as of October 9, 1985 is incorporated by reference to Exhibit A to the Prospectus of the Registrant dated October 28, 1985 as filed with the Commission pursuant to Rule 424(b) under the Act.



3A

Second Amendment dated April 1, 1986 to the Partnership Agreement dated July 8, 1985 as amended October 9, 1985 is incorporated by reference to Exhibit 3A to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.



4

Certificate of Limited Partnership dated June 28, 1985 is incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on form S-11 (Registration No. 2-99257).



10L

Contract for Sale of Real Estate for Plainview Apartments dated November 11, 1985 between NTS-Plainview Partners, a Kentucky limited partnership and Tennessee Trust Company, a Tennessee corporation, is incorporated by reference to Exhibit 10(a) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10M

Assignment of Contract for Sale of Real Estate dated May 2, 1986 between Tennessee Trust Company, a Tennessee corporation and the Registrant is incorporated by reference to Exhibit 10(b) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10N

Amendment and Reinstatement of Contract for Sale of Real Estate dated April 15, 1986 between NTS-Plainview Partners and Tennessee Trust Company is incorporated by reference to Exhibit 10(c) to the Registrant's Current Report on Form 8-K dated May 6, 1986.



10AA

Amended, Restated and Substituted Mortgage Note dated November 15, 1995, executed by Plainview Apartments, L.P. payable to NTS-Plainview Associates is incorporated by reference to Exhibit 10AA to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1995.



10BB

Assignment of Leases, Rents, and Profits dated November 15, 1995, executed by Plainview Apartments, L.P. to Nationwide Life Insurance Co. and West Coast Life Insurance Co. is incorporated by reference to Exhibit 10BB to the Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1995.



10DD a)

Purchase and Sale Contract dated August 16, 2005 between Salem Courthouse, L.P. and Prime Quest Management, LLC is incorporated by reference to the Registrants Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2005.



10DD b)

First Amendment to Purchase and Sale Contract dated September 23, 2005 between Salem Courthouse, L.P. and Prime Quest Management, LLC is incorporated by reference to the Registrants Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2005.



10DD c)

Reinstatement and Second Amendment to Purchase and Sale Contract dated October 11, 2005 between Salem Courthouse, L.P. and Prime
Quest Management, LLC is incorporated by reference to the Registrants Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2005.



31.1

Certification of equivalent of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



31.2

Certification of equivalent of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



32.1

Certification of the equivalent of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



99A

Agreement of Limited Partnership for Davidson III GP Limited Partnership between Davidson Diversified Properties, Inc. and Davidson Diversified Real Estate III entered into on September 15, 1993.



99B

Agreement of Limited Partnership for Salem Courthouse L.P. between Davidson III GP Limited Partnership and Davidson Diversified Real Estate III, L.P. entered into on September 15, 1993.





Exhibit 31.1

CERTIFICATION

I, Martha L. Long, certify that:

1.

I have reviewed this quarterly report on Form 10-QSB of Davidson Diversified Real Estate III, L.P.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;



3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;



4.

The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have:



(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;



(b)

Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and



(c)

Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and



5.

The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions):



(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and



(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting.

Date:  November 13, 2006

/s/Martha L. Long

Martha L. Long

Senior Vice President of Davidson Diversified Properties, Inc., equivalent of the chief executive officer of the Partnership







Exhibit 31.2

CERTIFICATION

I, Stephen B. Waters, certify that:

1.

I have reviewed this quarterly report on Form 10-QSB of Davidson Diversified Real Estate III, L.P.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;



3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;



4.

The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have:



(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;



(b)

Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and



(c)

Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and



5.

The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions):



(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and



(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting.

Date:  November 13, 2006

/s/Stephen B. Waters

Stephen B. Waters

Vice President of Davidson Diversified Properties, Inc., equivalent of the chief financial officer of the Partnership







21







Exhibit 32.1





Certification of CEO and CFO

Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002







In connection with the Quarterly Report on Form 10-QSB of Davidson Diversified Real Estate III, L.P. (the "Partnership"), for the quarterly period ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Martha L. Long, as the equivalent of the Chief Executive Officer of the Partnership, and Stephen B. Waters, as the equivalent of the Chief Financial Officer of the Partnership, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:



(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and



(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Partnership.





| |                        
| | -----------------------
| | /s/Martha L. Long      
| | Name: Martha L. Long   
| | Date: November 13, 2006
| |                        
| | /s/Stephen B. Waters   
| | Name: Stephen B. Waters
| | Date: November 13, 2006





This certification is furnished with this Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Partnership for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.







22