UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                           Washington, D.C.  20549
                      ----------------------------------

                                  FORM 10-Q

    |X|       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                       SECURITIES EXCHANGE ACT OF 1934

                 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997

                                      OR

            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

                     For the transition period from ____to _____ .


                            Commission File Number:  0-10979



            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
             -------------------------------------------------------
             (Exact name of registrant as specified in its charter)



           Delaware                                            13-3038189
           --------                                            ----------
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                            Identification No.)


265 Franklin Street, Boston, Massachusetts                      02110
------------------------------------------                      -----
(Address of principal executive offices)                        (Zip Code)


Registrant's telephone number, including area code  (617) 439-8118
                                                    --------------

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed  by  Section  13 or 15 (d) of the  Securities  Exchange  Act of 1934
during the preceding 12 months (or for such shorter  period that the  registrant
was  required  to file such  reports),  and (2) has been  subject to such filing
requirements for the past 90 days. Yes |X| No |_|.


<PAGE>

           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                                BALANCE SHEETS
               June 30, 1997 and September 30, 1996 (Unaudited)
                                (In thousands)

                                    ASSETS

                                                         June 30  September 30
                                                         -------  ------------
Operating investment property, at cost:
   Land                                                 $     950    $    950
   Building and improvements                                4,088       4,088
                                                        ---------    --------
                                                            5,038       5,038
   Less accumulated depreciation                           (1,466)     (1,389)
                                                        ---------    --------
                                                            3,572       3,649

Investments in joint ventures, at equity                    2,841       2,844
Cash and cash equivalents                                     848       1,000
Accounts receivable                                            99          99
Deferred expenses, net                                         37          53
Note and interest receivable, net                               -           -
                                                        ---------    --------
                                                        $   7,397    $  7,645
                                                        =========    ========

                      LIABILITIES AND PARTNERS' CAPITAL

Accounts payable - affiliates                           $       4    $      4
Accounts payable and accrued expenses                          65          60
Mortgage note payable                                       1,315       1,420
Partners' capital                                           6,013       6,161
                                                        ---------    --------
                                                        $   7,397    $  7,645
                                                        =========    ========

              STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
          For the nine months ended June 30, 1997 and 1996 (Unaudited)
                                 (In thousands)

                                               General           Limited
                                               Partner           Partners
                                               -------           --------

Balance at September 30, 1995                 $    (61)         $  5,619
Cash distributions                                  (3)             (314)
Net income                                          62             6,138
                                              --------           -------
Balance at June 30, 1996                      $     (2)          $11,443
                                              ========           =======

Balance at September 30, 1996                 $      -           $ 6,161
Cash distributions                                  (3)             (316)
Net income                                           2               169
                                              --------           -------
Balance at June 30, 1997                      $     (1)          $ 6,014
                                              ========           =======




                           See accompanying notes.


<PAGE>


            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                            STATEMENTS OF OPERATIONS
     For the three and nine months ended June 30, 1997 and 1996 (Unaudited)
                     (In thousands, except per Unit amounts)

                                      Three Months Ended      Nine Months Ended
                                           June 30,                 June 30,
                                    --------------------    -------------------
                                     1997        1996         1997        1996
                                     ----        ----         ----        ----

Revenues:
   Rental revenues                $   119     $   119    $    358      $  358
   Interest income                     13          17          40          27
                                  -------     -------    --------      ------
                                      132         136         398         385

Expenses:
   Interest expense                    36          39         109         118
   Management fees                      5           5          13          13
   Depreciation expense                26          26          77          77
   General and administrative         171          99         314         274
                                  -------     -------    --------      ------
                                      238         169         513         482
                                  -------     -------    --------      ------

Operating loss                       (106)        (33)       (115)        (97)

Partnership's share of 
  ventures' income                     97          24         286         263

Partnership's share of gain 
  on sale of operating 
  investment property                   -       6,034           -       6,034
                                  -------     -------    --------      ------

Net income (loss)                 $    (9)    $ 6,025    $    171      $6,200
                                  =======     =======    ========      ======

Net income (loss) per Limited
  Partnership Unit                 $(0.41)    $276.83      $ 7.86     $284.83
                                   ======     =======      ======     =======


Cash distributions per Limited
  Partnership Unit                 $ 4.88     $  4.85      $14.64     $ 14.55
                                   ======     ======       ======     =======


   The above net income (loss) and cash  distributions  per Limited  Partnership
Unit are based upon the 21,550 Units of Limited Partnership Interest outstanding
for each period.











                           See accompanying notes.


<PAGE>


            PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                            STATEMENTS OF CASH FLOWS
          For the nine months ended June 30, 1997 and 1996 (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
                                 (In thousands)

                                                         1997           1996
                                                         ----           ----
Cash flows from operating activities:
   Net income                                         $    171      $   6,200
   Adjustments to reconcile net income to
    net cash used in operating activities:
     Depreciation expense                                   77             77
     Amortization of deferred financing costs               16             16
     Partnership's share of ventures' income              (286)          (263)
     Partnership's share of gain on sale of operating
       investment property                                   -         (6,034)
     Changes in assets and liabilities:
      Accounts payable and accrued expenses                  5            (10)
                                                      --------      ---------
        Total adjustments                                 (188)        (6,214)
                                                      --------      ---------
        Net cash used in operating activities              (17)           (14)

Cash flows from investing activities:
   Distributions from joint ventures                       289          6,581

Cash flows from financing activities:
   Distributions to partners                              (319)          (317)
   Principal payments on mortgage note payable            (105)           (96)
                                                      --------      ---------
        Net cash used in financing activities             (424)          (413)
                                                      --------      ---------

Net (decrease) increase in cash and cash equivalents      (152)         6,154

Cash and cash equivalents, beginning of period           1,000            296
                                                      --------      ---------

Cash and cash equivalents, end of period              $    848      $   6,450
                                                      ========      =========

Cash paid during the period for interest              $     93      $     102
                                                      ========      =========
















                           See accompanying notes.


<PAGE>


           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP
                        Notes to Financial Statements
                                 (Unaudited)


1.   General

         The accompanying financial statements,  footnotes and discussion should
     be  read  in  conjunction  with  the  financial  statements  and  footnotes
     contained in the  Partnership's  Annual Report for the year ended September
     30,  1996.  In  the  opinion  of  management,  the  accompanying  financial
     statements,  which have not been audited, reflect all adjustments necessary
     to  present  fairly  the  results  for  the  interim  period.  All  of  the
     adjustments  reflected in the accompanying interim financial statements are
     of a normal recurring nature.

         The accompanying financial statements have been prepared on the accrual
      basis of accounting  in  accordance  with  generally  accepted  accounting
      principles  which requires  management to make  estimates and  assumptions
      that affect the reported amounts of assets and liabilities and disclosures
      of contingent assets and liabilities as of June 30, 1997 and September 30,
      1996 and  revenues  and  expenses  for each of the three-  and  nine-month
      periods ended June 30, 1997 and 1996. Actual results could differ from the
      estimates and assumptions used.

2.    Related Party Transactions

         Management fees earned by the Adviser  totalled $13,000 for each of the
      nine-month  periods  ended  June 30,  1997 and  1996.  Accounts  payable -
      affiliates  at June 30, 1997 and  September 30, 1996 consists of $4,000 of
      management fees payable to the Adviser at both dates.

         Included in general  and  administrative  expenses  for the nine months
      ended  June 30,  1997  and  1996 is  $50,000  and  $55,000,  respectively,
      representing  reimbursements  to an affiliate  of the General  Partner for
      providing  certain  financial,   accounting  and  investor   communication
      services to the Partnership.

         Also  included  in general  and  administrative  expenses  for the nine
      months  ended June 30, 1997 and 1996 is $6,000 and  $1,000,  respectively,
      representing fees earned by an affiliate,  Mitchell Hutchins Institutional
      Investors, Inc., for managing the Partnership's cash assets.

3.   Real Estate Investments

         As  of June 30,  1997,  the  Partnership  directly  owns one  operating
     investment  property  (Northeast  Plaza) and has  investments  in two joint
     venture  partnerships  (three at June 30, 1996) as more fully  described in
     the Partnership's  Annual Report. On June 19, 1996, the joint venture which
     owned the Camelot Apartments sold the operating  investment  property to an
     unrelated third party for $15,150,000.  The Partnership  received net sales
     proceeds of approximately  $5.9 million after deducting  closing costs, the
     repayment  of the  outstanding  first  mortgage  loans,  the  buyout  of an
     underlying  ground lease and the  co-venturers'  share of the net proceeds.
     The Partnership  made a special  distribution to the Limited  Partners from
     the  Camelot  sale  proceeds of  approximately  $5.5  million,  or $256 per
     original $1,000 investment,  on August 15, 1996. The remaining net proceeds
     were added to the Partnership's  cash reserves to provide for the potential
     capital needs of the  Partnership's  remaining  investments.  Subsequent to
     quarter ended June 30,1997,  on August 1, 1997,  the  Partnership  sold its
     interest in the Pine Trail Shopping Center to its joint venture partner for
     a net price of $6,150,000. As a result of this transaction, the Partnership
     will make a special capital distribution to the Limited Partners of $285.25
     per original  $1,000  investment on September 15, 1997. The  Partnership no
     longer holds an interest in this property.

         The  joint   ventures  are  accounted  for by using the  equity  method
     because  the  Partnership  does not have a voting  control  interest in the
     ventures.  Under the equity method, the assets,  liabilities,  revenues and
     expenses of the joint ventures do not appear in the Partnership's financial
     statements.  Instead,  the investments are carried at cost adjusted for the
     Partnership's share of the ventures' earnings, losses and distributions.


<PAGE>


         Summarized  operating  results of the joint  ventures for the three and
     nine months ended June 30, 1997 and 1996 are as follows:

                    Condensed Combined Summary of Operations
           For the three and nine months ended June 30, 1997 and 1996
                                 (in thousands)

                                  Three Months Ended      Nine Months Ended
                                        June 30,               June 30,
                                   -----------------     ------------------
                                    1997      1996          1997     1996
                                    ----      ----          ----     ----

     Rental revenues and expense
        recoveries               $   885    $ 1,499     $  2,700    $ 4,492
     Interest and other income         9          2           16        128
                                 -------    -------     --------    -------
                                    894       1,501        2,716      4,620

     Property operating expenses    268         789          880      2,192
     Interest expense               328         440          993      1,310
     Depreciation and 
        amortization                142         204          383        608
                                -------     -------     --------    -------
                                    738       1,433        2,256      4,110
                                -------     -------     --------    -------

     Operating income               156          68          460        510

     Gain on sale of operating
       investment property            -      11,996            -     11,996
                                -------     -------     --------    -------

     Net income                 $   156    $ 12,064     $    460    $12,506
                                =======    ========     ========    =======

     Net income:
      Partnership's share of
        combined net income     $    98    $  7,520     $    289    $ 7,809
      Co-venturers' share of
        combined net income          58       4,544          171      4,697
                                -------    --------     --------    -------
                                $   156    $ 12,064     $    460    $12,506
                                =======    ========     ========    =======

               Reconciliation of Partnership's Share of Operations
           For the three and nine months ended June 30, 1997 and 1996
                                 (in thousands)

                                   Three Months Ended      Nine Months Ended
                                        June 30,               June 30,
                                   -----------------     ------------------
                                    1997      1996          1997     1996
                                    ----      ----          ----     ----

      Partnership's share of
         net income, as shown 
         above                     $    98    $ 7,520     $    289   $  7,809
      Amortization of excess
         basis                          (1)    (1,462)          (3)    (1,512)
                                   -------    -------     --------   --------
      Partnership's share of
         ventures' net income      $    97    $ 6,058     $    286   $  6,297
                                   =======    =======     ========   ========


<PAGE>



         The Partnership's share of ventures' net income is presented as follows
    in the accompanying statements of operations (in thousands):

                                  Three Months Ended      Nine Months Ended
                                        June 30,               June 30,
                                   -----------------     ------------------
                                    1997      1996          1997     1996
                                    ----      ----          ----     ----
      Partnership's share of
         ventures' income          $   97   $   24       $   286    $  263
      Partnership's share of
         gain on sale of 
         operating investment 
         property                       -    6,034             -     6,034
                                   ------   ------       -------    ------
   
                                   $   97   $ 6,058      $    286   $6,297
                                   ======   =======      ========   ======

4.  Note and Interest Receivable, Net

          Note and interest  receivable  at June 30, 1997 and September 30, 1996
     consists of a $3,445,336 note received in connection with the Partnership's
     sale of its joint  venture  interest  in the  Briarwood  joint  venture  in
     December of 1984.  The note has been netted  against  deferred  gain on the
     sale of a like amount on the  Partnership's  balance sheet.  The note bears
     interest at 9% annually,  matures on January 1, 2000 and is subordinated to
     a first  mortgage  loan.  Interest and  principal  payments on the note are
     payable only to the extent of net cash flow from the  properties  sold,  as
     defined in the sale  documents.  Any  interest  not  received  will  accrue
     additional  interest of 9% per annum. The Partnership's  policy has been to
     defer  recognition of all interest income on the note until collected,  due
     to the uncertainty of its collectibility.  To date, the Partnership has not
     received  any  interest  payments.  Per the  terms of the  note  agreement,
     accrued  interest  receivable  as of June 30,  1997 would be  approximately
     $6,710,000.  Since the  properties  securing the note  continue to generate
     operating deficits and the Partnership's note receivable is subordinated to
     other first  mortgage  debt,  there is  significant  uncertainty  as to the
     collectibility  of both the principal  and accrued  interest as of June 30,
     1997.  As a result,  the portion of the  remaining  gain to be  recognized,
     which is  represented by the note and accrued  interest,  has been deferred
     until realized in cash.

5.  Mortgage Note Payable and Contingencies

          The mortgage  note payable at June 30, 1997 and  September 30, 1996 is
     secured by the Partnership's  wholly-owned Northeast Plaza Shopping Center.
     On March 29, 1994,  the  Partnership  refinanced  the  existing  wraparound
     mortgage  note  secured by Northeast  Plaza,  which had been in default for
     over two  years,  with a new loan  issued  by the  prior  underlying  first
     mortgage  lender.  The  new  loan,  in  the  initial  principal  amount  of
     $1,722,000,  has a term of five years and bears interest at a fixed rate of
     9% per annum.  Monthly  principal  and interest  payments of  approximately
     $21,900  are due until  maturity  in May 1999.  The loan may be  prepaid at
     anytime  without  penalty.  The fair value of this  mortgage  note  payable
     approximated its carrying value as of June 30, 1997 and September 30, 1996.

          Management  believes  that  the  Partnership's   efforts  to  sell  or
     refinance the Northeast Plaza property have been impeded by potential buyer
     and  lender  concerns  of an  environmental  nature  with  respect  to  the
     property.  During 1990, it was discovered that certain  underground storage
     tanks at a Mobil service  station  located  adjacent to the shopping center
     had leaked and contaminated the groundwater in the vicinity of the station.
     Mobil  investigated  the leak and is progressing with efforts to remedy the
     soil and  groundwater  contamination  under the  supervision of the Florida
     Department of Environmental Regulation, which has approved Mobil's remedial
     action  plan.   During  fiscal  1990,  the   Partnership  had  obtained  an
     indemnification  agreement from Mobil Oil Corporation in which Mobil agreed
     to  bear  the  cost  of  all  damages  and  required   clean-up   expenses.
     Furthermore,  Mobil  indemnified the  Partnership  against its inability to
     sell,  transfer,  or  obtain  financing  on  the  property  because  of the
     contamination.  As a result  of the  contamination  of the  groundwater  at
     Northeast Plaza,  the Partnership has incurred  certain damages,  primarily
     related to the  inability to sell the property and to delays in the process
     of refinancing the property's  mortgage  indebtedness.  The Partnership has
     incurred  significant  out-of-pocket  and legal expenses in connection with
     such  sale  and  refinancing  efforts.  Despite  repeated  requests  by the
     Partnership  for  compensation  under  the  terms  of  the  indemnification
     agreement,   to  date  Mobil  has   disagreed  as  to  the  extent  of  the
     indemnification  and has refused to compensate the  Partnership  for any of
     these damages.

          During the first quarter of fiscal 1993, the Partnership filed suit in
     Federal Court against Mobil for breach of indemnity and property damage. On
     April 28, 1995,  Mobil was  successful  in  dismissing  the action from the
     Federal  Court  system  on  jurisdictional   grounds.   Subsequently,   the
     Partnership  filed an action in the Florida State Court system. On November
     14,  1996,  the state court  granted the  Partnership's  Motion for Partial
     Summary  Judgment as to liability with regard to the  Partnership's  claims
     for damages due to trespass and nuisance.  By obtaining a summary  judgment
     of liability and recently defeating Mobil's appeal of the summary judgment,
     the Partnership has firmly  established Mobil Oil  Corporation's  liability
     for the  trespass and nuisance  caused by the  contamination.  The trial on
     these  counts  will  focus   directly  on  the  damages   suffered  by  the
     Partnership.   In  addition,   the  trial  court  has  found  a  reasonable
     evidentiary  basis  for the  Partnership  to amend  its  complaint  to seek
     punitive damages against Mobil for certain intentional or grossly negligent
     conduct  which  caused  the  contamination  of the  Center.  The jury  will
     determine the  Partnership's  entitlement to  compensatory  and/or punitive
     damages, if any. Finally,  the trial court granted the Partnership leave to
     seek an  injunction  against Mobil to force them to complete the cleanup of
     the Center on an expedited  basis.  If the  Partnership  is  successful  at
     trial,  the injunction will likely advance the completion of the cleanup by
     several years. A trial date is expected to be set shortly by the Court. The
     Partnership   continues   to  be   concerned   about  the  impact  of  this
     contamination  on the  Partnership's  ability  to sell this  investment  on
     favorable  terms in the  future.  The  outcome of these  legal  proceedings
     cannot presently be determined. Accordingly, the out-of-pocket costs, legal
     fees and related  expenses  related to this situation have been expensed as
     incurred  on the  Partnership's  income  statements  and no estimate of the
     recoveries,  if any,  which  could  result from this  litigation  have been
     recorded.


<PAGE>



           PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP

                     MANAGEMENT'S DISCUSSION AND ANALYSIS
               OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


Liquidity and Capital Resources
-------------------------------

      Subsequent  to the end of the  third  quarter,  on  August  1,  1997,  the
Partnership  sold its  interest in the Pine Trail  Shopping  Center to its joint
venture  partner  for  a  net  price  of  $6,150,000.  Funds  to  complete  this
transaction  were provided from a refinancing of the first mortgage debt secured
by the Pine Trail  property.  As a result of this  transaction,  the Partnership
will make a special capital  distribution to the Limited Partners of $285.25 per
original  $1,000  investment on September 15, 1997.  The  Partnership  no longer
holds an interest in this  property.  The net price of  $6,150,000 is the amount
the  Partnership  would have received from a third-party  sale at any sale price
between  $13,800,000  and  $18,500,000.  Under the terms of the Pine Trail joint
venture  agreement,  the Partnership  was entitled to the first  $6,150,000 as a
first priority from the net sale proceeds after the payment of closing costs and
adjustments as well as the mortgage  indebtedness of  approximately  $7,700,000.
Then the  co-venture  partner  was  entitled  to the next  $4,156,000,  with any
remaining net sale proceeds split 50%/50%.  Under these terms,  the  Partnership
would not  receive  any  amount  above  $6,150,000  until the sale  price of the
property  exceeded  $18,500,000.  If a  sale  price  of  over  $18,500,000  were
achieved,  the Partnership and the co-venturer would share equally in any excess
over  $18,500,000.  Management  believed  that a sale price of  $18,500,000  was
unlikely  to be achieved  for several  years,  which was  supported  by the most
recent  independent  appraisal  of Pine  Trail  which  valued  the  property  at
$16,250,000. The net operating income from the Pine Trail Shopping Center is not
expected  to  improve  significantly  for the next  five  years  because  of the
long-term  leases and fixed  rental rates on the anchor and  out-parcel  leases,
which comprise 73% of the property's  total base rental income and nearly 82% of
the total net leasable  area.  One anchor's  lease term expires in January 2002,
two other anchor  leases  expire in November  2006,  and the fourth anchor lease
expires in January 2012. As a result of these circumstances, management believed
that  accepting the net sale price of $6,150,000 was in the  Partnership's  best
interests.

     At Central Plaza Shopping  Center in Lubbock,  Texas,  the occupancy  level
remained at 92% as of June 30, 1997,  unchanged from the prior quarter.  Despite
intensive  efforts by the property's  local leasing team,  the remaining  11,500
square feet of vacant space at the Center has not been leased.  The leasing team
has contacted  over 30 retailers.  However,  after  pursuing the most  promising
responses to these initial contacts,  they were unable to find a fit between the
retailers'  needs and the space  available at the Center.  To broaden the search
for tenants, a Dallas leasing firm has been engaged to focus on retailers in the
Dallas area that might be interested in entering the Lubbock market.

      As previously  reported,  the Partnership and its co-venture  partner have
been  exploring  potential  opportunities  to sell  Central  Plaza.  During  the
quarter,  it was agreed that management  would market the Center for sale rather
than wait to complete a lease-up of the remaining vacant space. Several regional
and national real estate brokerage firms were interviewed as candidates for this
assignment,  and a  Dallas-based  real estate  broker with a specialty in retail
properties  was selected to market the Central Plaza  Shopping  Center for sale.
The  marketing  process has begun,  and sale packages are being  distributed  to
prospective  buyers.  However,  there are no assurances that a sale  transaction
will be completed in the near term.

      The sale of the  Partnership's  interest  in Pine  Trail  and the plans to
market  Central  Plaza  for  sale  position  the   Partnership  for  a  possible
liquidation  within the next 2-to-3 years  pending the  resolution of the issues
affecting the Partnership's Northeast Plaza investment.  As previously reported,
management  believes  that the  Partnership's  efforts to sell or refinance  the
Northeast  Plaza property have been impeded by potential  lender  concerns of an
environmental  nature  with  respect  to  the  property.  During  1990,  it  was
discovered  that certain  underground  storage tanks at a Mobil service  station
located  adjacent to the shopping center had leaked and  contaminated the ground
water  in the  vicinity  of the  station.  Mobil  investigated  the  leak and is
progressing with efforts to remedy the soil and ground water contamination under
the supervision of the Florida Department of Environmental Regulation, which has
approved Mobil's  remedial action plan.  During fiscal 1990, the Partnership had
obtained a formal indemnification  agreement from Mobil Oil Corporation in which
Mobil  agreed to bear the cost of all damages and  required  clean-up  expenses.
Furthermore,  Mobil  indemnified the Partnership  against its inability to sell,
transfer or obtain financing on the property because of the contamination.  As a
result  of the  contamination  of the  ground  water  at  Northeast  Plaza,  the
Partnership has incurred certain damages,  primarily related to the inability to
sell the property  and to delays in the process of  refinancing  the  property's
mortgage  indebtedness.  The Partnership has incurred significant  out-of-pocket
and legal expenses in connection with such sale and refinancing efforts. Despite
repeated  requests by the  Partnership for  compensation  under the terms of the
indemnification  agreement,  to date Mobil has disagreed as to the extent of the
indemnification  and has refused to compensate the  Partnership for any of these
damages.

      During the first  quarter of fiscal 1993,  the  Partnership  filed suit in
Federal  Court against  Mobil for breach of indemnity  and property  damage.  On
April 28, 1995,  Mobil was  successful in dismissing the action from the Federal
Court system on jurisdictional grounds.  Subsequently,  the Partnership filed an
action in the Florida State Court system.  On November 14, 1996, the state court
granted the  Partnership's  Motion for Partial Summary  Judgment as to liability
with  regard  to the  Partnership's  claims  for  damages  due to  trespass  and
nuisance.  By obtaining a summary  judgment of liability and recently  defeating
Mobil's appeal of the summary judgment,  the Partnership has firmly  established
Mobil Oil  Corporation's  liability for the trespass and nuisance  caused by the
contamination.  The trial on these  counts  will focus  directly  on the damages
suffered by the Partnership. In addition, the trial court has found a reasonable
evidentiary  basis for the  Partnership  to amend its complaint to seek punitive
damages against Mobil for certain intentional or grossly negligent conduct which
caused  the   contamination   of  the  Center.   The  jury  will  determine  the
Partnership's  entitlement to  compensatory  and/or  punitive  damages,  if any.
Finally,  the trial court  granted the  Partnership  leave to seek an injunction
against  Mobil to  force  them to  complete  the  cleanup  of the  Center  on an
expedited  basis. If the Partnership is successful at trial, the injunction will
likely  advance the  completion of the cleanup by several years. A trial date is
expected  to be set  shortly  by the  Court.  The  Partnership  continues  to be
concerned about the impact of this contamination on the Partnership's ability to
sell this  investment  on  favorable  terms in the future.  The outcome of these
legal proceedings cannot presently be determined.

      The Northeast  Plaza property,  which the  Partnership  master leases to a
local manager/operator, was 100% leased and 92% occupied as of June 30, 1997. As
reported  last  quarter,  a 10,000  square foot tenant  moved out of the Center.
However,  a new  five-year  lease for this space was signed  with an  automobile
supply store.  The  automobile  supply store is completing  its build-out and is
expected to move in by September  30, 1997.  Two tenants  signed lease  renewals
during the quarter.  Both tenants, one whose 900 square foot lease was scheduled
to expire  in April,  and the  other,  whose  1,890  square  foot  lease was not
scheduled to expire until 1998, signed new five-year leases.

      At June 30, 1997, the Partnership had available cash and cash  equivalents
of $848,000.  Such cash and cash  equivalents  will be used for working  capital
requirements and  distributions to the partners.  The source of future liquidity
and  distributions to the partners is expected to be through cash generated from
the operations of the Partnership's  income-producing  investment properties and
proceeds  received from the sale or refinancing  of such  properties or sales of
the  Partnership's  interests in such properties.  Such sources of liquidity are
expected to be sufficient to meet the  Partnership's  needs on both a short-term
and long-term basis. In addition,  the Partnership has a note receivable that it
received  as a portion  of the  proceeds  from the sale of its  interest  in the
Briarwood  joint venture in fiscal 1985. The note and related  accrued  interest
receivable  have been  netted  against a deferred  gain of a like  amount on the
accompanying  balance  sheet.  The  interest  owed  on the  note  receivable  is
currently payable only to the extent that the related properties generate excess
net cash flow.  To date,  no  payments  have been  received  on the note,  which
matures on January 1, 2000, and none are expected in the near future.  Since the
operating  properties  continue  to  generate  net cash  flow  deficits  and the
Partnership's  note  receivable is  subordinated  to the existing first mortgage
debt, there is significant uncertainty as to the collectibility of the principal
and accrued interest.  Proceeds,  if any, received on the note would represent a
source of additional liquidity for the Partnership.


<PAGE>


Results of Operations
Three Months Ended June 30, 1997
--------------------------------

      The  Partnership  reported a net loss of $9,000 for the three months ended
June 30, 1997,  as compared to net income of  $6,025,000  for the same period in
the prior  year.  The  unfavorable  change in the  Partnership's  net  operating
results  for the  current  three-month  period is  primarily  the  result of the
Partnership's  share  of the  gain  from  the  June  1996  sale  of the  Camelot
Apartments  recognized in the prior three-month  period.  The gain recognized by
the Camelot joint venture totalled  $11,996,000 and the  Partnership's  share of
such gain  amounted  to  $6,034,000,  net of the  write-off  of the  unamortized
balance  of the  Partnership's  excess  basis in the  Camelot  joint  venture of
$1,437,000.  In addition, a $73,000 increase in the Partnership's operating loss
contributed  to  the   unfavorable   change  in  net  operating   results.   The
Partnership's  operating  loss  increased  due  to a  $69,000  increase  in  the
Partnership's  operating  expenses and a $4,000 decrease in interest income. The
Partnership's  operating  expenses increased mainly due to a $72,000 increase in
general  and  administrative  expenses.   General  and  administrative  expenses
increased due to a $79,000  increase in legal fees  incurred  during the current
three-month  period as a result of the  continued  litigation  against Mobil Oil
Corporation,  as  discussed  further  above.  The  increase  in  legal  fees was
partially  offset by a decline in certain other required  professional  services
during the current period. The increase in general and  administrative  expenses
was partially offset by a $3,000 decrease in interest expense.  Interest expense
decreased  due to a reduction in the  outstanding  balance of the mortgage  note
payable  secured by the  Partnership's  wholly-owned  Northeast  Plaza  Shopping
Center due to the required monthly principal payments. Interest income decreased
due to a decrease in the Partnership's  average outstanding cash balances during
the current  three-month  period  resulting from the receipt of the Camelot sale
proceeds  in June  1996  and  the  temporary  investment  prior  to the  special
distribution to the Limited Partners on August 15, 1996.

      The gain on the Camelot  sale in the prior  period and the increase in the
Partnership's  operating loss were partially offset by a $73,000 increase in the
Partnership's  share of ventures' income for the current three-month period. The
Partnership's  share of ventures'  income increased mainly due to a $56,000 loss
recognized in the prior year from the Camelot joint venture  through the date of
the sale on June 19,  1996,  and a $23,000  increase  in net  income at the Pine
Trail joint  venture  when  compared  to the same period in the prior year.  Net
income  increased  at Pine  Trail  mainly  due to a $17,000  increase  in rental
revenues and an $8,000 decrease in interest expense.  Rental revenues  increased
as a result of increases in rental rates when compared to the same period in the
prior year.  Interest  expense  decreased due to a reduction in the  outstanding
balance of the  mortgage  note  payable due to the  required  monthly  principal
payments.

Nine Months Ended June 30, 1997
-------------------------------

      The Partnership  reported net income of $171,000 for the nine months ended
June 30, 1997,  as compared to net income of  $6,200,000  for the same period in
the prior year. The substantial decrease in the Partnership's net income for the
current nine-month period is primarily the result of the Partnership's  share of
the gain from the June 1996 sale of the  Camelot  Apartments  recognized  in the
prior nine-month period, as discussed above. In addition, an $18,000 increase in
the Partnership's  operating loss contributed to the decline in net income.  The
Partnership's  operating  loss  increased  due  to a  $31,000  increase  in  the
Partnership's  operating  expenses,  which  was  partially  offset  by a $13,000
increase in interest income.  The  Partnership's  operating  expenses  increased
mainly due to a $40,000 increase in general and administrative expenses. General
and  administrative  expenses increased due to a $107,000 increase in legal fees
incurred  during  the  current  nine-month  period as a result of the  continued
litigation  against  Mobil Oil  Corporation,  as discussed  further  above.  The
increase  in legal  fees was  partially  offset by a decline  in  certain  other
required  professional  services  during the  current  period.  The  increase in
general and administrative expenses was partially offset by a $9,000 decrease in
interest  expense.  Interest  expense  decreased  due  to  a  reduction  in  the
outstanding  balance of the mortgage note payable  secured by the  Partnership's
wholly-owned  Northeast  Plaza  Shopping  Center  due  to the  required  monthly
principal  payments.  Interest  income  increased  due  to an  increase  in  the
Partnership's  average  outstanding cash balances during the current  nine-month
period  resulting  from the  retention of a portion of the Camelot sale proceeds
subsequent to the June 1996 sale transaction.

      The  gain on the  Camelot  sale  and  the  increase  in the  Partnership's
operating loss was partially offset by a $23,000  increase in the  Partnership's
share of ventures' income for the current  nine-month  period. The Partnership's
share of  ventures'  income  increased  due to  increases  in net  income at the
Central   Plaza  and  Pine  Trail  joint   ventures  of  $52,000  and   $49,000,
respectively.  Net income  increased at Central Plaza primarily due to decreases
in maintenance  costs and real estate tax expense.  Net income increased at Pine
Trail mainly due to an increase in rental  revenues  resulting from increases in
rental rates when  compared to the same period in the prior year.  The increases
in net income at the Central  Plaza and Pine Trail joint  ventures was partially
offset by the  inclusion of the operating  results of the Camelot  Apartments in
the prior year's figure.  The  Partnership's  share of operating income from the
Camelot joint venture through the date of the sale in the prior year, net of the
amortization of excess basis, was $51,000.




<PAGE>


                                     PART II
                                Other Information

Item 1. Legal Proceedings


      As previously reported,  the Partnership's  General Partners were named as
defendants  in  a  class  action  lawsuit   against   PaineWebber   Incorporated
("PaineWebber") and a number of its affiliates relating to PaineWebber's sale of
70 direct  investment  offerings  of interests  in various  limited  partnership
investments  and REIT stocks,  including  those offered by the  Partnership.  In
January  1996,  PaineWebber  signed  a  memorandum  of  understanding  with  the
plaintiffs in the class action  outlining the terms under which the parties have
agreed to  settle  the  case.  Pursuant  to that  memorandum  of  understanding,
PaineWebber  irrevocably  deposited  $125  million into an escrow fund under the
supervision of the United States District Court for the Southern District of New
York to be used to  resolve  the  litigation  in  accordance  with a  definitive
settlement agreement and plan of allocation.  On July 17, 1996,  PaineWebber and
the class plaintiffs submitted a definitive  settlement agreement which provides
for the complete  resolution of the class action litigation,  including releases
in favor of the Partnership and the General Partners,  and the allocation of the
$125 million  settlement  fund among  investors in the various  partnerships  at
issue in the case. As part of the settlement, PaineWebber also agreed to provide
class  members  with  certain  financial  guarantees  relating  to  some  of the
partnerships.  The details of the  settlement  are  described in a notice mailed
directly to class members at the direction of the court.  A final hearing on the
fairness  of the  settlement  was held in December  1996,  and in March 1997 the
court issued a final approval of the settlement. The release of the $125 million
of  settlement  proceeds has not occurred to date pending the  resolution  of an
appeal of the settlement  agreement by two of the plaintiff  class  members.  As
part  of  the  settlement   agreement,   PaineWebber  has  agreed  not  to  seek
indemnification  from the related partnerships and real estate investment trusts
at issue in the litigation  (including the  Partnership) for any amounts that it
is required to pay under the settlement.

      In June  1996,  approximately  50  plaintiffs  filed  an  action  entitled
Bandrowski v. PaineWebber Inc. in Sacramento,  California Superior Court against
PaineWebber   Incorporated  and  various  affiliated   entities  concerning  the
plaintiffs' purchases of various limited partnership interests,  including those
offered by the  Partnership.  The complaint  alleged,  among other things,  that
PaineWebber and its related entities committed fraud and  misrepresentation  and
breached  fiduciary  duties  allegedly  owed to the  plaintiffs  by  selling  or
promoting  limited   partnership   investments  that  were  unsuitable  for  the
plaintiffs and by overstating the benefits,  understating  the risks and failing
to state  material  facts  concerning  the  investments.  The  complaint  sought
compensatory  damages of $3.4 million plus punitive damages against PaineWebber.
In September 1996, the court dismissed many of the plaintiffs'  claims as barred
by applicable securities arbitration regulations.  Mediation with respect to the
Bandrowski  action was held in December 1996. As a result of such  mediation,  a
settlement between PaineWebber and the plaintiffs was reached which provided for
the complete  resolution  of such action.  Final  releases and  dismissals  with
regard to this action were received during the quarter ended June 30, 1997.

      Based on the  settlement  agreements  discussed  above covering all of the
outstanding unitholder  litigation,  and notwithstanding the appeal of the class
action  settlement  referred  to  above,  management  does not  expect  that the
resolution  of these  matters will have a material  impact on the  Partnership's
financial statements, taken as a whole.

      With regard to the Partnership's  litigation against Mobil Oil Corporation
related to the groundwater contamination at the Northeast Plaza Shopping Center,
on  November  14,  1996 the state court  granted  the  Partnership's  Motion for
Partial Summary Judgment as to liability with regard to the Partnership's claims
for damages due to trespass and  nuisance.  By  obtaining a summary  judgment of
liability and recently  defeating  Mobil's appeal of the summary  judgment,  the
Partnership has firmly  established  Mobil Oil  Corporation's  liability for the
trespass and  nuisance  caused by the  contamination.  The trial on these counts
will focus directly on the damages suffered by the Partnership. In addition, the
trial court has found a  reasonable  evidentiary  basis for the  Partnership  to
amend  its  complaint  to  seek  punitive  damages  against  Mobil  for  certain
intentional or grossly  negligent  conduct which caused the contamination of the
Center.  The jury will determine the  Partnership's  entitlement to compensatory
and/or  punitive  damages,  if  any.  Finally,   the  trial  court  granted  the
Partnership leave to seek an injunction  against Mobil to force them to complete
the  cleanup  of  the  Center  on an  expedited  basis.  If the  Partnership  is
successful at trial,  the  injunction  will likely advance the completion of the
cleanup by several  years.  A trial date is  expected  to be set  shortly by the
Court.  The  Partnership  continues  to be  concerned  about the  impact of this
contamination on the Partnership's  ability to sell this investment on favorable
terms in the future.  The outcome of these legal proceedings cannot presently be
determined.


<PAGE>




Item 2. through 5.      NONE

Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits:          NONE

(b)  Reports on Form 8-K:

     No reports on Form 8-K have been filed by the registrant during the quarter
for which this report is filed.




<PAGE>





                PAINE WEBBER INCOME PROPERTIES THREE LIMITED PARTNERSHIP


                                   SIGNATURES


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

                      PAINE WEBBER INCOME PROPERTIES THREE
                               LIMITED PARTNERSHIP


                                   By:  THIRD INCOME PROPERTIES, INC.
                                        General Partner




                                    By:/s/ Walter V. Arnold
                                       ---------------------
                                       Walter V. Arnold
                                       Senior Vice President and Chief
                                       Financial Officer


Date:  August 13, 1997