<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-Q


             Quarterly Report Pursuant to Section 13 or 15(d) of the
                        Securities Exchange Act of 1934

                For the Quarterly Period Ended SEPTEMBER 30, 1998

                         Commission File Number 0-10673

                       REAL ESTATE ASSOCIATES LIMITED III
                       (A California Limited Partnership)

                  I.R.S. Employer Identification No. 95-3547611

                         9090 WILSHIRE BLVD., SUITE 201
                           BEVERLY HILLS, CALIF. 90211

                         Registrant's Telephone Number,
                       Including Area Code (310) 278-2191


Indicate by check mark whether the registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding twelve months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.

                                Yes [X]  No [ ]
<PAGE>   2
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               INDEX TO FORM 10-Q

                    FOR THE QUARTER ENDED SEPTEMBER 30, 1998


<TABLE>
<S>      <C>                                                                                    <C>
PART I.  FINANCIAL INFORMATION

             Item 1.  Financial Statements

                      Balance Sheets, September 30, 1998 and December 31, 1997.................   1

                      Statements of Operations,
                              Nine and Three Months Ended September 30, 1998 and 1997 .........   2

                      Statement of Partners' Equity (Deficiency),
                              Nine months Ended September 30, 1998 ............................   3

                      Statements of Cash Flows,
                              Nine Months Ended September 30, 1998 and 1997 ...................   4

                      Notes to Financial Statements ...........................................   5

             Item 2.  Management's Discussion and Analysis of Financial
                              Condition and Results of Operations .............................  11

PART II.  OTHER INFORMATION

             Item 1.    Legal Proceedings......................................................  14

             Item 6.    Exhibits and Reports on Form 8-K.......................................  14

             Signatures .......................................................................  15
</TABLE>

<PAGE>   3
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                                 BALANCE SHEETS

                    SEPTEMBER 30, 1998 AND DECEMBER 31, 1997

                                     ASSETS

<TABLE>
<CAPTION>
                                                                  1998               1997
                                                              ------------       ------------
                                                               (Unaudited)
<S>                                                           <C>                <C>
INVESTMENTS IN LIMITED PARTNERSHIPS (Note 2)                  $  1,360,332       $  1,249,422

CASH AND CASH EQUIVALENTS (Note 1)                              11,563,458         10,575,810

OTHER ASSETS                                                       225,181            135,000
                                                              ------------       ------------
          TOTAL ASSETS                                        $ 13,148,971       $ 11,960,232
                                                              ============       ============

                         LIABILITIES AND PARTNERS' EQUITY

LIABILITIES:
     Notes payable (Notes 3 and 6)                            $  1,510,000       $  1,510,000
     Interest payable (Notes 3 and 6)                              400,485            414,277
     Accounts payable                                              118,888            110,193
                                                              ------------       ------------
                                                                 2,029,373          2,034,470
                                                              ------------       ------------

COMMITMENTS AND CONTINGENCIES (Notes 4 and 5)

PARTNERS' EQUITY (DEFICIENCY):
    General partners                                               (87,780)           (99,718)
    Limited partners                                            11,207,378         10,025,480
                                                              ------------       ------------
                                                                11,119,598          9,925,762
                                                              ------------       ------------
           TOTAL LIABILITIES AND PARTNERS'
                EQUITY                                        $ 13,148,971       $ 11,960,232
                                                              ============       ============
</TABLE>

     The accompanying notes are integral part of these financial statements.

                                        1
<PAGE>   4
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                            STATEMENTS OF OPERATIONS
             NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                           Nine months        Three months       Nine months        Three months
                                                              ended              ended              ended               ended
                                                          Sept. 30, 1998     Sept. 30, 1998     Sept. 30, 1997     Sept. 30, 1997
                                                          --------------     --------------     --------------     --------------
<S>                                                       <C>                <C>                <C>                <C>        
INTEREST AND OTHER INCOME                                   $   374,894        $   124,714        $   351,310        $   125,491
                                                            -----------        -----------        -----------        -----------
OPERATING EXPENSES:
           Legal and accounting                                 179,153             43,550            130,797             50,267
           Management fees - general partner (Note 4)           341,100            113,700            341,100            113,700
           Interest (Note 3)                                    113,250             37,750            113,250             37,750
           Administrative  (Notes 2 and 4)                      472,701            173,602             69,477             25,537
                                                            -----------        -----------        -----------        -----------
                Total operating expenses                      1,106,204            368,602            654,624            227,254
                                                            -----------        -----------        -----------        -----------
LOSS FROM OPERATIONS                                           (731,310)          (243,888)          (303,314)          (101,763)

DISTRIBUTIONS FROM LIMITED
      PARTNERSHIPS RECOGNIZED AS
      INCOME (Note 2)                                         1,733,146          1,083,961          1,072,912

EQUITY IN INCOME OF LIMITED
      PARTNERSHIPS AND AMORTI-
       ZATION OF ACQUISITION
       COSTS (Note 2)                                           192,000             64,000            192,000             64,000
                                                            -----------        -----------        -----------        -----------
NET INCOME (LOSS)                                           $ 1,193,836        $   904,073        $   961,598        $   (37,763)
                                                            ===========        ===========        ===========        ===========
NET INCOME PER LIMITED PARTNERSHIP
     INTEREST (Note 1)                                      $       104        $         5        $        84        $        (3)
                                                            ===========        ===========        ===========        ===========
</TABLE>

    The accompanying notes are integral part of these financial statements.


                                        2
<PAGE>   5
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                   STATEMENTS OF PARTNERS' EQUITY (DEFICIENCY)
                  FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
                                   (Unaudited)

<TABLE>
<CAPTION>
                                            General          Limited
                                            Partners         Partners            Total
                                            --------        -----------       -----------
<S>                                         <C>             <C>               <C>
PARTNERSHIP INTERESTS                                            11,456
                                                            ===========
EQUITY (DEFICIENCY),
       January 1, 1998                      $(99,718)       $10,025,480       $ 9,925,762

       Net income for the nine months
       ended September 30, 1998               11,938          1,181,898         1,193,836
                                            --------        -----------       -----------
EQUITY (DEFICIENCY),
       September 30, 1998                   $(87,780)       $11,207,378       $11,119,598
                                            ========        ===========       ===========
</TABLE>

    The accompanying notes are integral part of these financial statements.


                                       3
<PAGE>   6
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                            STATEMENTS OF CASH FLOWS
              FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                         1998               1997
                                                                     ------------       ------------
<S>                                                                  <C>                <C>         
CASH FLOWS FROM OPERATING ACTIVITIES:
       Net income                                                    $  1,193,836       $    961,598
       Adjustments to reconcile net income to net cash
         provided by operating activities:
         Equity in income of limited partnerships and
         amortization of acquisition costs                               (192,000)          (192,000)
       Increase in other assets                                           (90,181)                --
       (Decrease) increase in interest and other payables                  (5,096)            60,129
                                                                     ------------       ------------
         Net cash provided by operating activities                        906,559            829,727
                                                                     ------------       ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
       Distribution from limited partnership
         recognized as a return of investment                              81,089             41,228
                                                                     ------------       ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS                                 987,648            870,955

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                         10,575,810          9,734,531
                                                                     ------------       ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                             $ 11,563,458       $ 10,605,486
                                                                     ============       ============
SUPPLEMENTAL DISCLOSURE OF
       CASH FLOW INFORMATION:
         Cash paid during the period for interest                    $    127,042       $     91,395
                                                                     ============       ============
</TABLE>

     The accompanying notes are integral part of these financial statements.


                                        4
<PAGE>   7
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS

                               SEPTEMBER 30, 1998


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         GENERAL

         The information contained in the following notes to the financial
         statements is condensed from that which would appear in the annual
         audited financial statements; accordingly, the financial statements
         included herein should be reviewed in conjunction with the financial
         statements and related notes thereto contained in the Real Estate
         Associates Limited III (the "Partnership") annual report for the year
         ended December 31, 1997. Accounting measurements at interim dates
         inherently involve greater reliance on estimates than at year end. The
         results of operations for the interim period presented are not
         necessarily indicative of the results for the entire year.

         In the opinion of the Partnership, the accompanying unaudited financial
         statements contain all adjustments (consisting primarily of normal
         recurring accruals) necessary to present fairly the financial position
         as of September 30, 1998 and the results of operations for the nine and
         three months then ended and changes in cash flows for the nine months
         then ended.

         The general partners have a 1 percent interest in profits and losses of
         the Partnership. The limited partners have the remaining 99 percent
         interest which is allocated in proportion to their respective
         individual investments. National Partnership Investments Corp. (NAPICO)
         is the corporate general partner of the Partnership. NAPICO is a wholly
         owned subsidiary of Casden Investment Corporation, which is wholly
         owned by Alan I. Casden.

         USE OF ESTIMATES

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and reported amounts of revenues and
         expenses during the reporting period. Actual results could differ from
         those estimates.

         METHOD OF ACCOUNTING FOR INVESTMENT IN LIMITED PARTNERSHIPS

         The investment in limited partnerships is accounted for on the equity
         method. Acquisition, selection and other costs related to the
         acquisition of the projects are capitalized as part of the investment
         account, and are being amortized on a straight line basis over the
         estimated lives of the underlying assets, which is generally 30 years.

         NET INCOME PER LIMITED PARTNERSHIP INTEREST

         Net income per limited partnership interest was computed by dividing
         the limited partners' share of net income by the number of limited
         partnership interests outstanding during the year. The number of
         limited partnership interests was 11,456 for the periods presented.


                                        5
<PAGE>   8
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                               SEPTEMBER 30, 1998

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         CASH AND CASH EQUIVALENTS

         Cash and cash equivalents consist of cash and bank certificates of
         deposit with an original maturity of three months or less. The
         Partnership has its cash and cash equivalents on deposit primarily with
         two high credit quality institutions. Such cash and cash equivalents
         are in excess of the FDIC insurance limit.

         INCOME TAXES

         No provision has been made for income taxes in the accompanying
         financial statements since such taxes, if any, are the liability of the
         individual partners

         IMPAIRMENT OF LONG-LIVED ASSETS

         The Partnership reviews long-lived assets to determine if there has
         been any permanent impairment whenever events or changes in
         circumstances indicate that the carrying amount of the asset may not be
         recoverable. If the sum of the expected future cash flows is less than
         the carrying amount of the assets, the Partnership recognizes an
         impairment loss.

NOTE 2 - INVESTMENTS IN LIMITED PARTNERSHIPS

         The Partnership holds limited partnership interests in 26 limited
         partnerships. In addition, the Partnership holds a general partner
         interest in REA. NAPICO is also a general partner in REA. REA, in turn,
         holds limited partner interests in nine additional limited
         partnerships. In total, therefore, the Partnership holds interest,
         either directly or indirectly including through REA, 32 partnerships
         which own residential rental projects consisting of 3,062 apartment
         units. The mortgage loans of these projects are insured by the United
         States Department of Housing and Urban Development ("HUD") or state
         governmental agencies.

         The Partnership, as a limited partner, is entitled to between 75
         percent and 99 percent of the profits and losses of the limited
         partnerships it has invested in directly. The Partnership is also
         entitled to 99.9 percent of the profits and losses of REA. REA holds a
         99 percent interest in each of the limited partnerships in which it has
         invested.


                                        6
<PAGE>   9
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                               SEPTEMBER 30, 1998


NOTE 2 - INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)

         Equity in losses of limited partnerships is recognized in the financial
         statements until the limited partnership investment account is reduced
         to a zero balance. Losses incurred after the limited partnership
         investment account is reduced to zero are not recognized.

         Distributions from limited partnerships are recognized as a reduction
         of capital until the investment balance has been reduced to zero.
         Subsequent distributions received are recognized as income.

         The following is a summary of the investment in limited partnerships
         for the nine months ended September 30, 1998:

<TABLE>
<CAPTION>
         <S>                                                      <C>
         Balance, beginning of period                             $1,249,421
         Distribution recognized as return of capital                (81,089)
         Amortization of acquisitions costs                          (40,500)
         Equity in income of limited partnerships                    232,500
                                                                  ----------
         Balance, end of period                                   $1,360,332
                                                                  ==========
</TABLE>

         The following are unaudited combined estimated statements of operations
         for the nine and three months ended September 30, 1998 and 1997 for the
         limited partnerships in which the Partnership has investments:

<TABLE>
<CAPTION>
                              Nine months          Three months          Nine months         Three months
                                 ended                ended                ended                 ended
                             Sept. 30, 1998       Sept. 30, 1998        Sept. 30,1997        Sept. 30, 1997
                             --------------       --------------        -------------        --------------
<S>                          <C>                  <C>                   <C>                  <C>
REVENUES
     Rental and other         $ 17,379,000         $  5,793,000         $ 16,791,000          $  5,597,000
                              ------------         ------------         ------------          ------------

EXPENSES
     Depreciation                2,754,000              918,000            2,817,000               939,000
     Interest                    5,196,000            1,732,000            5,271,000             1,757,000
     Operating                   9,039,000            3,013,000            9,327,000             3,109,000
                              ------------         ------------         ------------          ------------
                                16,989,000            5,663,000           17,415,000             5,805,000
                              ------------         ------------         ------------          ------------

NET (LOSS) INCOME             $    390,000         $    130,000         $   (624,000)         $   (208,000)
                              ============         ============         ============          ============
</TABLE>

         NAPICO, or one of its affiliates, is the general partner and property
         management agent for certain of the limited partnerships included
         above.


                                        7
<PAGE>   10
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                               SEPTEMBER 30, 1998


NOTE 2 - INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)

    Under recently adopted law and policy, HUD has determined not to renew
    housing assistance payments contracts ("HAP Contracts") on their existing
    terms. In connection with renewals of the HAP Contracts under such new law
    and policy, the amount of rental assistance payments under renewed HAP
    Contracts will be based on market rentals instead of above market rentals,
    which was generally the case under existing HAP Contracts. As a result,
    existing HAP Contracts that are renewed in the future on projects insured by
    the Federal Housing Administration of HUD ("FHA") will not provide
    sufficient cash flow to permit owners of properties to meet the debt service
    requirements of these existing FHA-insured mortgages. In order to address
    the reduction in payments under HAP Contracts as a result of this new
    policy, the Multi-family Assisted Housing Reform and Affordability Act of
    1997 ("MAHRAA"), which was adopted in October 1997, provides for the
    restructuring of mortgage loans insured by the FHA with respect to
    properties subject to HAP Contracts that have been renewed under the new
    policy. The restructured loans will be held by the current lender or another
    lender. Under MAHRAA, an FHA-insured mortgage loan can be restructured to
    reduce the annual debt service on such loan. There can be no assurance that
    the Partnership will be permitted to restructure its mortgage indebtedness
    pursuant to the new HUD rules implementing MAHRAA or that the Partnership
    would choose to restructure such mortgage indebtedness if it were eligible
    to participate in the MAHRAA program. It should be noted that there are
    uncertainties as to the economic impact on the Partnership of the
    combination of the reduced payments under the HAP Contracts and the
    restructuring of the existing FHA-insured mortgage loans under MAHRAA.
    Accordingly, the General Partners are unable to predict with certainty their
    impact on the Partnership's future cash flow.

    As a result of the foregoing, the Partnership is undergoing an extensive
    review of the properties in which the limited partnerships have invested
    that are subject to HUD mortgages and which may be sold to the REIT as set
    forth below. The Partnership has incurred expenses in connection with this
    review by various third party professionals, including accounting, legal,
    valuation, structural review and engineering costs, which amounted to
    approximately $651,000 through September 30, 1998 including approximately
    $511,000 and $56,000 for the nine months ended September 30, 1998 and 1997,
    respectively, which are included in general and administrative expenses.

    A real estate investment trust ("REIT") organized by affiliates of NAPICO
    has advised the Partnership that it intends to make a proposal to purchase
    from the Partnership certain of the limited partnership interests held for
    investment by the Partnership.

    The REIT proposes to purchase such limited partnership interests for cash,
    which it plans to raise in connection with a private placement of its equity
    securities. The purchase is subject to, among other things, (i) consummation
    of such private placement by the REIT; (ii) the purchase of the general
    partnership interests in the local limited partnerships by the REIT; (iii)
    the approval of HUD and certain state housing finance agencies; (iv) the
    consent of the limited partners to the sale of the local limited partnership
    interests held for investment by REAL III; and (v) the consummation of a
    minimum number of purchase transactions with other NAPICO affiliated
    partnerships.


                                        8
<PAGE>   11
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                               SEPTEMBER 30, 1998


NOTE 2 - INVESTMENTS IN LIMITED PARTNERSHIPS (CONTINUED)

    A consent solicitation statement has been sent to the limited partners
    setting forth the terms and conditions of the purchase of the limited
    partners' interests held for investment by the Partnership, together with
    certain amendments to the Partnership Agreement and other disclosures of
    various conflicts of interest in connection with the proposed transaction.
    As of November 2, 1998, the consents of the limited partners to the sale of
    the partnership interests and amendments to the Partnership Agreement have
    been obtained. In addition, the REIT has completed buy-out negotiations with
    a majority of the general partners of the local limited partnerships and has
    obtained approval from HUD.

NOTE 3 - NOTES PAYABLES

    Certain of the Partnership's investments involved purchases of partnership
    interests from partners who subsequently withdrew from the operating
    partnerships. The Partnership is obligated on non-recourse notes payable of
    $1,510,000, bearing interest at 10 percent, to the sellers of the
    partnership interests. These notes are payable by the Partnership through
    REA, and have principal maturity dates in June 2020 and March 2024 or upon
    the sale or refinancing of the underlying partnership properties. These
    notes and the related interest are collateralized by REA's investment in the
    respective limited partnerships and are payable only out of cash
    distributions from the investee partnerships, as defined in the notes.
    Unpaid interest is due at maturity of the notes.

NOTE 4 - MANAGEMENT FEE AND EXPENSES DUE TO GENERAL PARTNER

    Under the terms of the Restated Certificate and Agreement of Limited
    Partnership, the Partnership is obligated to NAPICO for an annual management
    fee approximately equal to .4 percent of the invested assets. Invested
    assets are defined as the costs of acquiring project interests, including
    the proportionate amount of the mortgage loans related to the Partnership's
    interests in the capital accounts of the respective partnership. The
    management fee incurred for the nine months ended September 30, 1998 and
    1997 was approximately $341,100.

    The Partnership reimburses NAPICO for certain expenses. The reimbursement
    paid to NAPICO was approximately $26,400 and $24,400 for the nine months
    ended September 30, 1998 and 1997, respectively, and is included in
    administrative expenses.

NOTE 5 - CONTINGENCIES

    On August 27, 1998, two investors holding an aggregate of eight units of
    limited partnership interests in Real Estate Associates Limited III (an
    affiliated partnership in which NAPICO is the managing general partner) and
    two investors holding an aggregate of five units of limited partnership
    interest in Real Estate Associates Limited VI (another affiliated
    partnership in which NAPICO is the managing general partner) commenced an
    action in the United States District Court for the Central District of
    California against the Partnership, NAPICO and certain other affiliated
    entities. The complaint alleges that the defendants breached their fiduciary
    duty to the limited partners of certain NAPICO managed partnerships and made
    materially false and misleading statements in the consent solicitation
    statements


                                        9
<PAGE>   12
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                               SEPTEMBER 30, 1998


NOTE 5 - CONTINGENCIES (CONTINUED)

    sent to the limited partners of such partnerships relating to approval of
    the transfer of partnership interests in limited partnerships, owning
    certain of the properties, to the REIT (Note 2). The plaintiffs seek
    preliminary and permanent injunctive relief and other equitable relief, as
    well as compensatory and punitive damages. The managing general partner of
    such NAPICO partnerships and the other defendants believe that the
    plaintiffs' claims are without merit and intend to contest the action
    vigorously.

    The corporate general partner of the Partnership is involved in various
    lawsuits arising from transactions in the ordinary course of business. In
    the opinion of management and the corporate general partner, the claims will
    not result in any material liability to the Partnership.

    The Partnership has assessed the potential impact of the Year 2000 computer
    systems issue on its operations. The Partnership believes that no
    significant actions are required to be taken by the Partnership to address
    the issue and that the impact of the Year 2000 computer systems issue will
    not materially affect the Partnership's future operating results or
    financial condition.

NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS

    Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
    Value of Financial Instruments," requires disclosure of fair value
    information about financial instruments, when it is practicable to estimate
    that value. The notes payable are collateralized by the Partnership's
    investments in the investee limited partnerships and are payable only out of
    cash distributions from the investee partnerships. The operations generated
    by the investee limited partnerships are subject to various government
    rules, regulations and restrictions which make it impracticable to estimate
    the fair value of the notes payable and related accrued interest. The
    carrying amount of other assets and liabilities reported on the balance
    sheets that require such disclosure approximates fair value due to their
    short-term maturity.


                                       10
<PAGE>   13
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               SEPTEMBER 30, 1998


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

    LIQUIDITY AND CAPITAL RESOURCES

    The Partnership's primary sources of funds include interest income earned
    from investing available cash and distributions from limited partnerships in
    which the Partnership has invested. It is not expected that any of the local
    limited partnerships in which the Partnership has invested will generate
    cash flow sufficient to provide for distributions to the Partnership's
    limited partners in any material amount.

    RESULTS OF OPERATIONS

    Partnership revenues consist primarily of interest income earned on
    certificates of deposit and other temporary investment of funds not required
    for investment in local partnerships.

    Operating expenses consist primarily of recurring general and administrative
    expenses and professional fees for services rendered to the Partnership. In
    addition, an annual Partnership management fee in an amount equal to .4
    percent of investment assets is payable to the corporate general partner.

    The Partnership accounts for its investments in the local limited
    partnerships on the equity method, thereby adjusting its investment balance
    by its proportionate share of the income or loss of the local limited
    partnerships. Losses incurred after the limited partnership investment
    account is reduced to zero are not recognized in accordance with the equity
    accounting method.

    Distributions received from limited partnerships are recognized as return of
    capital until the investment balance has been reduced to zero or to a
    negative amount equal to future capital contributions required. Subsequent
    distributions received are recognized as income. Overall distributions from
    limited partnerships continue to be favorable. This primarily is due, to
    improved operating results at several of the properties.

    Except for certificates of deposit and money market funds, the Partnership's
    investments are entirely interests in other limited partnerships owning
    government assisted projects. Funds temporarily not required for such
    investments in projects are invested in certificate of deposit and money
    market funds which provide substantial amounts of interest as reflected in
    the statement of operations. These investments are converted to cash to meet
    obligations as they arise. The Partnership intends to continue investing
    available funds in this manner.

    The Partnership is obligated on non-recourse notes payable of $1,510,000
    which bear interest at 10 percent per annum and have principal maturities
    ranging from June 2020 to March 2024. The notes and related interest are
    payable from cash flow generated from operations of the related rental
    properties as defined in the notes. These obligations are collateralized by
    the Partnership's investments in the limited partnerships. Unpaid interest
    is due at maturity of the notes. Because no payments have been made on these
    notes, interest expense has remained constant for each of the three years.


                                       11
<PAGE>   14
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               SEPTEMBER 30, 1998


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

    RESULTS OF OPERATIONS (CONTINUED)

    Under recently adopted law and policy, HUD has determined not to renew
    housing assistance payments contracts ("HAP Contracts") on their existing
    terms. In connection with renewals of the HAP Contracts under such new law
    and policy, the amount of rental assistance payments under renewed HAP
    Contracts will be based on market rentals instead of above market rentals,
    which was generally the case under existing HAP Contracts. As a result,
    existing HAP Contracts that are renewed in the future on projects insured by
    the Federal Housing Administration of HUD ("FHA") will not provide
    sufficient cash flow to permit owners of properties to meet the debt service
    requirements of these existing FHA-insured mortgages. In order to address
    the reduction in payments under HAP Contracts as a result of this new
    policy, the Multi-family Assisted Housing Reform and Affordability Act of
    1997 ("MAHRAA"), which was adopted in October 1997, provides for the
    restructuring of mortgage loans insured by the FHA with respect to
    properties subject to HAP Contracts that have been renewed under the new
    policy. The restructured loans will be held by the current lender or another
    lender. Under MAHRAA, an FHA-insured mortgage loan can be restructured to
    reduce the annual debt service on such loan. There can be no assurance that
    the Partnership will be permitted to restructure its mortgage indebtedness
    pursuant to the new HUD rules implementing MAHRAA or that the Partnership
    would choose to restructure such mortgage indebtedness if it were eligible
    to participate in the MAHRAA program. It should be noted that there are
    uncertainties as to the economic impact on the Partnership of the
    combination of the reduced payments under the HAP Contracts and the
    restructuring of the existing FHA-insured mortgage loans under MAHRAA.
    Accordingly, the General Partners are unable to predict with certainty their
    impact on the Partnership's future cash flow.

    As a result of the foregoing, the Partnership is undergoing an extensive
    review of the properties in which the limited partnerships have invested
    that are subject to HUD mortgages and which may be sold to the REIT as set
    forth below. The Partnership has incurred expenses in connection with this
    review by various third party professionals, including accounting, legal,
    valuation, structural review and engineering costs, which amounted to
    approximately $651,000 through September 30, 1998 including approximately
    $511,000 and $56,000 for the nine months ended September 30, 1998 and 1997,
    respectively, which are included in general and administrative expenses.

    A real estate investment trust ("REIT") organized by affiliates of NAPICO
    has advised the Partnership that it intends to make a proposal to purchase
    from the Partnership certain of the limited partnership interests held for
    investment by the Partnership.

    The REIT proposes to purchase such limited partnership interests for cash,
    which it plans to raise in connection with a private placement of its equity
    securities. The purchase is subject to, among other things, (i) consummation
    of such private placement by the REIT; (ii) the purchase of the general
    partnership interests in the local limited partnerships by the REIT; (iii)
    the approval of HUD and certain state housing finance agencies; (iv) the
    consent of the limited partners to the sale of the local limited partnership
    interests held for investment by REAL III; and (v) the consummation of a
    minimum number of purchase transactions with other NAPICO affiliated
    partnerships.


                                       12
<PAGE>   15
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               SEPTEMBER 30, 1998


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

    RESULTS OF OPERATIONS (CONTINUED)

    A consent solicitation statement has been sent to the limited partners
    setting forth the terms and conditions of the purchase of the limited
    partners' interests held for investment by the Partnership, together with
    certain amendments to the Partnership Agreement and other disclosures of
    various conflicts of interest in connection with the proposed transaction.
    As of November 2, 1998, the consents of the limited partners to the sale of
    the partnership interests and amendments to the Partnership Agreement have
    been obtained. In addition, the REIT has completed buy-out negotiations with
    a majority of the general partners of the local limited partnerships and has
    obtained approval from HUD.


                                       13
<PAGE>   16
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               SEPTEMBER 30, 1998


PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

    On August 27, 1998, two investors holding an aggregate of eight units of
    limited partnership interests in Real Estate Associates Limited III (an
    affiliated partnership in which NAPICO is the managing general partner) and
    two investors holding an aggregate of five units of limited partnership
    interest in Real Estate Associates Limited VI (another affiliated
    partnership in which NAPICO is the managing general partner) commenced an
    action in the United States District Court for the Central District of
    California against the Partnership, NAPICO and certain other affiliated
    entities. The complaint alleges that the defendants breached their fiduciary
    duty to the limited partners of certain NAPICO managed partnerships and made
    materially false and misleading statements in the consent solicitation
    statements sent to the limited partners of such partnerships relating to
    approval of the transfer of partnership interests in limited partnerships,
    owning certain of the properties, to the REIT (Note 2). The plaintiffs seek
    preliminary and permanent injunctive relief and other equitable relief, as
    well as compensatory and punitive damages. The managing general partner of
    such NAPICO partnerships and the other defendants believe that the
    plaintiffs' claims are without merit and intend to contest the action
    vigorously.

    The corporate general partner is involved in various lawsuits. None of these
    are related to REAL III.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

    A report 8-K relating to an unsolicited offer to buy units of limited
    partnership interests (the "Units"), as discussed below, was filed with the
    Securities and Exchange Commission during the quarter ended September 30,
    1998.

    On June 26, 1998, Bond Purchase, L.L.C. (the "Buyer") made an unsolicited
    tender offer to buy a certain number of Units in the Partnership for a price
    of $312 per Unit. The Buyer did not contact the Corporate General Partner
    prior to commencing its tender offer. By letter dated July 15, 1998, the
    Corporate General Partner advised limited partners that it had determined
    not to take a position with respect to the tender offer but cautioned
    limited partners to consider certain items before determining whether to
    tender their Units to the Buyer. A copy of the letter from the Buyer is
    attached as an Exhibit to this form 10-Q.


                                       14
<PAGE>   17
                       REAL ESTATE ASSOCIATES LIMITED III
                       (A CALIFORNIA LIMITED PARTNERSHIP)

                               SEPTEMBER 30, 1998

                                   SIGNATURES

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

                                   REAL ESTATE ASSOCIATES LIMITED III
                                   (a California limited partnership)

                                   By:   National Partnership Investments Corp.
                                         General Partner

                                         /s/ PAUL PATIERNO
                                         ---------------------------------------
                                         Paul Patierno
                                         Chief Financial Officer

                                   Date: 
                                         ---------------------------------------

                                         /s/  CHARLES H. BOXENBAUM
                                         ---------------------------------------
                                         Charles H. Boxenbaum
                                         Chief Executive Officer

                                   Date: 
                                         ---------------------------------------


                                       15
<PAGE>   18
BOND PURCHASE L.L.C.
P.O. Box 26730
Kansas City, MO 64196

June 26, 1998

To the Holders of Limited Partnership Interests in Real Estate Associates 
Limited III.

RE: OFFER TO PURCHASE LIMITED PARTNERSHIP INTERESTS FOR $312.00

Dear Investor:

     We are offering you an opportunity to sell your limited partnership 
interests (the "Units") in Real Estate Associates Limited III (the 
"Partnership") for cash in the amount of $312.00 per Unit (which amount will be 
reduced by any cash distributions declared by the Partnership after the date of 
this letter). Our offer provides you with an opportunity to sell your Units now 
without the costly transfer fees and commission costs (typically up to 10%) 
usually paid by the seller in secondary market sales. ALL TRANSFER COSTS AND 
FEES WILL BE PAID BY BOND PURCHASE, L.L.C.

     We believe that it is appropriate for investors to have financial choices. 
Our offer gives you, the investor, the ability to make a decision about your 
continued involvement with the Partnership. You may no longer wish to continue 
with your investment in the Partnership for a number of reasons, including:

     * NO FURTHER IRS FILING.

     * HIGHEST OFFER - This offer is higher than the last reported trade of 
       $304 (October 1, 1997 to December 31, 1997) in the secondary market.

     * If you sell your units, 1998 will be the fiscal year for which you 
       receive a K-1 tax form from the partnership.

     * You may be able to realize a tax loss that would reduce your taxes for 
       1998.

     * The Partnership was closed seventeen years ago in 1981. Your money has 
       been tied up for this long period with minimal return.

     * More immediate use for the cash tied up in your investment in the Units.

     * The absence of a formal trading market for the Units and their resulting 
       relative illiquidity.
<PAGE>   19
     * The lack of any current cash distributions.

     * General disenchantment with real estate investments, particularly 
       long-term investments in limited partnerships;

     Our offer is limited to 570 of the 11,456 outstanding Units. If we were to 
acquire more than this amount, the administrative costs of our offer would 
become burdensome.

     We will accept for purchase properly documented Units on a 
"first-received, first-buy" basis. You will be paid promptly following 
confirmation of a valid, properly executed Agreement of Transfer and other 
required transfer documents. We will pay for all Partnership transfer fees and 
costs. All tenders of Units will be irrevocable and may not be rescinded or 
withdrawn.

     We are real estate investors who are not affiliated with the Partnership 
or the General Partners. The General Partners of the Partnership have not 
analyzed, approved, endorsed or made any recommendation as to acceptance of the 
offer. The purchase offer has been determined solely at the discretion of Bond 
Purchase, L.L.C. and does not necessarily represent the true market value of 
each unit. We are seeking to acquire Units for investment purposes only and not 
with a view to their resale.

     An Agreement of Transfer is enclosed which you can use to accept our 
offer. Please execute page 3 of this document, as well as the Power of 
Attorney. Obtain all other required signatures and return the documentation in 
the enclosed envelope. Please note that all signatures must be medallion 
guaranteed. The transfer cannot be processed without signatures that are 
medallion guaranteed and failure to obtain them will result in needless delays. 
In addition, place your Unit Certificate in the enclosed envelope. We 
encourage you to act immediately if you are interested in accepted or offer as 
only 570 Units will be purchased.

     OUR OFFER WILL EXPIRE AT 5:00 PM ON JULY 31, 1998, UNLESS EXTENDED.

     Please call John Katzer at (816) 421-4670 if you have any questions.

Sincerely,

Bond Purchase, L.L.C.