<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                   FORM 10-Q

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

                 ---------------------------------------------

      For Quarter Ended September 30, 1997  Commission File Number 0-17809


                        COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP
             (Exact name of registrant as specified in its charter)


        Massachusetts                                 04-3005973
(State or other jurisdiction of          (I.R.S. Employer Identification No.)
incorporation or organization)

     225 Franklin Street, 25th Fl.
     Boston, Massachusetts                              02110
(Address of principal executive offices)              (Zip Code)

              Registrant's telephone number, including area code:
                                 (617) 261-9000


--------------------------------------------------------------------------------
Former name, former address and former fiscal year if changed since last report


     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve (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>
 
                        COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP

                                   FORM 10-Q


                      FOR QUARTER ENDED SEPTEMBER 30, 1997


                                     PART I

                             FINANCIAL INFORMATION
                                        
<PAGE>
 
BALANCE SHEETS
(Unaudited)

<TABLE> 
<CAPTION> 
                             September 30, 1997  December 31, 1996
                             ------------------  -----------------
<S>                          <C>                 <C>
Assets
 
Real estate investments:
 Joint venture                      $ 5,179,888        $ 5,531,652
 Property, net                        7,396,361         11,789,227
                                    -----------        -----------
                                     12,576,249         17,320,879
 
Cash and cash equivalents             1,641,658          1,798,785
Short-term investments                  695,528            503,111
                                    -----------        -----------
 
                                    $14,913,435        $19,622,775
                                    ===========        ===========

Liabilities and Partners' Capital
 
 
Accounts payable                    $    52,172        $    45,692
Accrued management fee                   41,117             41,420
Deferred disposition fee                 29,250                 --
                                    -----------        -----------
 Total liabilities                      122,539             87,112
                                    -----------        -----------
 
Partners' capital (deficit):
 
 Limited partners ($800 and $1,000 per
  unit, respectively; 100,000 units
  authorized, 27,641 units issued
  and outstanding)                   14,830,040         19,582,641
 General partners                       (39,144)           (46,978)
                                    -----------        -----------
Total partners' capital              14,790,896         19,535,663
                                    -----------        -----------
                                                       
                                    $14,913,435        $19,622,775
                                    ===========        ===========
</TABLE>

                (See accompanying notes to financial statements)
<PAGE>
 
STATEMENTS OF OPERATIONS (Unaudited)

<TABLE>
<CAPTION>
                                              Nine                   Nine
                                Quarter      Months     Quarter     Months
                                 Ended        Ended      Ended       Ended
                               September    September  September   September
                                30, 1997    30, 1997    30, 1996   30, 1996
                              ------------ ----------- ---------- -----------
<S>                           <C>          <C>         <C>        <C>
Investment Activity                                              
                                                                 
Property rentals               $  214,762  $  987,674  $ 375,815  $1,146,579
Property operating expenses       (39,187)   (158,512)   (48,766)   (165,707)
Depreciation and amortization     (97,101)   (314,422)  (108,660)   (319,752)
                               ----------  ----------  ---------  ----------
                                   78,474     514,740    218,389     661,120
                                                                  
Joint venture earnings             81,662     234,833     67,224     236,603
                               ----------  ----------  ---------  ----------
  Total real estate operations    160,136     749,573    285,613     897,723
                                                                 
Gain on sale of property        1,490,313   1,490,313         --          --
                               ----------  ----------  ---------  ----------
  Total real estate activity    1,650,449   2,239,886    285,613     897,723
                                                                 
Interest on cash equivalents                                     
  and short-term investments       31,824      89,156     25,606      77,654
                               ----------  ----------  ---------  ----------
                                                                 
  Total investment activity     1,682,273   2,329,042    311,219     975,377
                               ----------  ----------  ---------  ----------
                                                                 
Portfolio Expenses                                               
                                                                 
Management fee                     41,117     130,860     41,420     124,260
General and administrative         26,728      88,540     27,187      80,891
                               ----------  ----------  ---------  ----------
                                   67,845     219,400     68,607     205,151
                               ----------  ----------  ---------  ----------
                                                                 
Net Income                     $1,614,428  $2,109,642  $ 242,612  $  770,226
                               ==========  ==========  =========  ==========
</TABLE> 
<PAGE>
 
<TABLE> 
<S>                            <C>         <C>         <C>        <C> 
Net income per limited                                           
 partnership unit              $    57.82  $    75.56  $    8.69  $    27.59
                               ==========  ==========  =========  ==========
                                                                 
Cash distributions per                                           
 limited partnership unit      $   216.25  $   247.50  $   15.00  $    45.00
                               ==========  ==========  =========  ==========
                                                                 
Number of limited partnership  
 units outstanding during the                                         
   period                          27,641      27,641     27,641      27,641
                               ==========  ==========  =========  ==========
</TABLE>
                (See accompanying notes to financial statements)
<PAGE>
 
STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
(Unaudited)

<TABLE>
<CAPTION>
                              Quarter Ended          Nine Months Ended          Quarter Ended          Nine Months Ended
                           September 30, 1997       September 30, 1997       September 30, 1996        September 30, 1996
                         -----------------------  -----------------------  -----------------------  ------------------------
 
                         General      Limited     General      Limited     General      Limited      General      Limited
                         Partners    Partners     Partners    Partners     Partners    Partners     Partners     Partners
                         --------   -----------   --------   -----------   --------   -----------   ---------   -----------
<S>                      <C>        <C>           <C>        <C>           <C>        <C>           <C>         <C>
 Balance at beginning
    of period            $(50,751)  $19,209,122   $(46,978)  $19,582,641   $(43,909)  $19,886,505    $(40,809)  $20,193,397
 
 Cash distributions        (4,537)   (5,977,366)   (13,262)   (6,841,147)    (4,188)     (414,615)    (12,564)   (1,243,845)
 
 Net income                16,144     1,598,284     21,096     2,088,546      2,426       240,186       7,702       762,524
                         --------   -----------   --------   -----------   --------   -----------   ---------   -----------
 
 Balance at end of
 period                  $(39,144)  $14,830,040   $(39,144)  $14,830,040   $(45,671)  $19,712,076    $(45,671)  $19,712,076
                         ========   ===========   ========   ===========   ========   ===========   =========   ===========
</TABLE>

                (See accompanying notes to financial statements)
<PAGE>
 
SUMMARIZED STATEMENTS OF CASH FLOWS
(Unaudited)

<TABLE>
<CAPTION>
                                          Nine Months Ended September 30,
                                          ------------------------------ 
                                                 1997          1996
                                             -----------   -----------
<S>                                          <C>           <C>
Net cash provided by operating activities    $ 1,170,226   $ 1,415,364
                                             -----------   -----------
 
Cash flows from investing activities:
  Net proceeds from sale of property           5,686,165             -
  Increase in deferred disposition fees           29,250             -
  Investment in property                               -      (186,836)
  Decrease (increase) in short-term
     investments, net                           (188,359)      401,671
                                             -----------   -----------
     Net cash provided by
       investing activities                    5,527,056       214,835
                                             -----------   -----------
Cash flows from financing activity:
  Distributions to partners                   (6,854,409)   (1,256,409)
                                             -----------   -----------
 
Net increase (decrease) in
  cash and cash equivalents                     (157,127)      373,790
 
Cash and cash equivalents:
  Beginning of period                          1,798,785     1,695,180
                                             -----------   -----------
 
  End of period                              $ 1,641,658   $ 2,068,970
                                             ===========   ===========
</TABLE>

Non-cash transaction:

Effective January 1, 1996, the Partnership's joint venture investment in South
Bay/CRIP 3 Associates was converted to a wholly-owned property.  The carrying
value of this investment at conversion was $4,180,704.

                (See accompanying notes to financial statements)
<PAGE>
 
NOTES TO FINANCIAL STATEMENTS (Unaudited)


   In the opinion of management, the accompanying unaudited financial statements
contain all adjustments necessary to present fairly the Partnership's financial
position as of September 30, 1997 and December 31, 1996 and the results of its
operations, its cash flows and partners' capital (deficit) for the interim
periods ended September 30, 1997 and 1996.  These adjustments are of a normal
recurring nature.

   See notes to financial statements included in the Partnership's 1996 Annual
Report on Form 10-K for additional information relating to the Partnership's
financial statements.


NOTE 1 - ORGANIZATION AND BUSINESS
----------------------------------

   Copley Realty Income Partners 3; A Limited Partnership (the "Partnership") is
a Massachusetts limited partnership organized for the purpose of investing
primarily in newly-constructed and existing income-producing real properties.
The Partnership commenced operations in October 1988, and acquired the two real
estate investments it currently owns prior to the end of 1989.  The Partnership
intends to dispose of its investments within six to nine years of their
acquisition, and then liquidate.  The Partnership has engaged AEW Real Estate
Advisors, Inc. (the "Advisor") to provide asset management advisory services.


NOTE 2 - PROPERTY
-----------------

   Effective January 1, 1996, the South Bay/CRIP 3 Associates joint venture was
restructured and the venture partner's ownership interest was assigned 99% to
the Partnership, and 1% to an affiliate of the Partnership.  Accordingly, since
this date, the investment has been accounted for as a wholly-owned property.
The carrying value of the joint venture investment at conversion ($4,180,704)
was allocated to land, building and improvements, and other net operating
assets.
 
   On July 22, 1997, the South Bay property was sold to the sole tenant which
exercised the purchase option under its lease for gross consideration of
$5,850,000.  The Partnership received net proceeds of $5,715,415, after closing
costs, and recognized a gain of $1,490,313 ($53.38 per limited partnership unit)
on the sale.  A disposition fee of $29,250 was accrued but not paid to the
Advisor.  On July 24, 1997, the Partnership made a capital distribution of
$5,528,200 ($200 per limited partnership unit) from the proceeds of the sale.
<PAGE>
 
   The following is a summary of the Partnership's investments in wholly-owned
property (one in 1997 and two in 1996):

<TABLE>
<CAPTION>
                                  September 30, 1997   December 31, 1996
                                  -------------------  ------------------
<S>                               <C>                  <C>
Land                                     $ 2,991,854         $ 5,771,144
Building and improvements                  5,978,755           9,601,263
Accumulated depreciation                  (1,890,684)         (1,758,213)
Investment valuation allowance                    --          (2,400,000)
Deferred costs, net                          382,767             445,638
Other net assets (liabilities)               (66,331)            129,395
                                         -----------         -----------
Net carrying value                       $ 7,396,361         $11,789,227
                                         ===========         ===========
</TABLE>


NOTE 3 - REAL ESTATE JOINT VENTURES
-----------------------------------

  The following summarized financial information is presented in the aggregate
for the Shasta Way joint venture:

<TABLE>
<CAPTION>
 
                                         Assets and Liabilities
                                         ---------------------- 

                                 September 30, 1997  December 31, 1996
                                 ------------------  -----------------
<S>                              <C>                 <C>
Assets
 Real property, at cost less
  accumulated depreciation of
  $2,026,733 and $1,709,771              $7,671,650         $7,988,613
 Other                                      255,038            515,758
                                         ----------         ----------
                                          7,926,688          8,504,371
 
Liabilities                                  92,921             74,585
                                         ----------         ----------
Net assets                               $7,833,767         $8,429,786
                                         ==========         ==========
</TABLE>
<PAGE>
 
<TABLE>
<CAPTION>
 
                                     Results of Operations
                                     ---------------------

                                  Nine Months Ended September 30,
                                         1997            1996
                                       --------        --------
<S>                                <C>            <C>
Revenue
 Rental income                     $    890,942   $     893,428
 Other                                    2,898           1,917
                                   ------------   -------------
                                        893,840         895,345
                                   ------------   -------------
 
Expenses
 Depreciation and amortization          345,589         140,868
 Operating expenses                     142,071         345,246
                                   ------------   -------------
                                        487,660         486,114
                                   ------------   -------------
 Net income                        $    406,180   $     409,231
                                   ============   =============
</TABLE>


  Liabilities and expenses exclude amounts owed and attributable to the
Partnership and its affiliate on behalf of their various financing arrangements
with the joint venture.


NOTE 4 - SUBSEQUENT EVENT
-------------------------

  Distributions of cash from operations relating to the quarter ended September
30, 1997 were made on October 30, 1997 in the amount of $415,732   ($14.89 per
limited partnership unit).
<PAGE>
 
Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations
-------------------------

Liquidity and Capital Resources

  The Partnership completed its offering of units of limited partnership
interest in June 1989 and a total of 27,641 units were sold.  The Partnership
received proceeds of $24,458,317, net of selling commissions and other offering
costs, which have been used for investment in real estate and to pay related
acquisition costs, or are being retained as working capital reserves.

  On July 22, 1997, the South Bay property was sold to the sole tenant which
exercised the purchase option under its lease for gross consideration of
$5,850,000.  The Partnership received net proceeds of $5,715,415, after closing
costs, and recognized a gain of $1,490,313 ($53.38 per limited partnership unit)
on the sale.  A disposition fee of $29,250 was accrued but not paid to the
Advisor.  On July 24, 1997, the Partnership made a capital distribution of
$5,528,200 ($200 per limited partnership unit) from the proceeds of the sale.
This distribution reduced the adjusted capital contribution to $800 per unit.

  At September 30, 1997, the Partnership had $2,337,186 in cash, cash
equivalents, and short-term investments, of which $415,732 was used for cash
distributions to partners on October 30, 1997; the remainder is being retained
for working capital reserves. The source of future liquidity and cash
distributions to partners will be cash generated by the Partnership's real
estate and short-term investments. Distributions of cash from operations
relating to the first three quarters of 1996 were made at the annualized rate of
6.0% on a capital contribution of $1,000 per unit. The annualized distribution
rate for the first two quarters of 1997 was increased to 6.5%, and then
increased again, to 7.0%, as of this third quarter. The third quarter 1997
distribution was based on the weighted average adjusted capital contribution.
The two increases in the distribution rate this year are due to increased cash
flow from Shasta Way, combined with the reduction in the adjusted capital
contribution as a result of the South Bay sale.

  The carrying value of real estate investments in the financial statements at
September 30, 1997 is at depreciated cost, or if the investment's carrying value
is determined not to be recoverable through expected undiscounted future cash
flows, the carrying value is reduced to estimated fair market value.  The fair
market value of such investments is further reduced by the estimated costs of
sale for properties held for sale.  Carrying value may be greater or less than
current appraised value.  At September 30, 1997, the aggregate appraised value
of the Partnership's investments was approximately $2,200,000 greater than their
aggregate carrying value.  The current appraised value of real estate
investments has been estimated by the managing general partner and is generally
based on a combination of traditional appraisal approaches performed by the
Advisor and independent appraisers.  Because of the subjectivity inherent in the
valuation process, the current appraised value may differ significantly from
that which could be realized if the real estate were actually offered for sale
in the marketplace.
<PAGE>
 
Results of Operations

  Form of Real Estate Investments

  The Brea West investment is a wholly-owned property. The South Bay investment,
which was also a wholly-owned property, was sold on July 22, 1997.  The Shasta
Way investment had been structured as a joint venture with a real estate
management/development firm and an affiliate of the Partnership.  As of January
1, 1996, the Shasta Way joint venture was restructured, and the
management/development firm's interest was assigned to the Partnership and its
affiliate in proportion to their respective ownership interests.  The
Partnership's ownership percentage increased to 58%.

  Operating Factors

  The Brea West and the Shasta Way properties are both 100% leased to single
tenants under long-term leases.  A new 11-year lease was signed during the
quarter with the tenant at Brea West which commenced on September 1, 1997.  The
lease at Shasta Way expires on December 31, 1998.

  Investment Results

  Interest earned on cash equivalents and short-term investments for the first
three quarters of 1997 increased by approximately $12,000, or 15%, as compared
to the same period in 1996 due to higher average invested balances, as well as
higher short-term yields.

  Real estate operations decreased approximately $148,000 for the first nine
months of 1997 as compared to the comparable period of 1996.  The decline was
primarily due to both the sale of the South Bay property in July 1997, and to
the write-off in 1997 of approximately $75,000 in tenant concessions, lease
commissions, and capitalized legal costs related to the old lease at Brea West.

  Cash provided by operations decreased by approximately $245,000 between the
nine-month periods ended September 30, 1997 and 1996.  The difference is
attributable to the decrease in operating results discussed above and to the
funding of $163,000 in commissions related to the new lease at Brea West.  These
decreases were partially offset by the timing of distributions from Shasta Way.
<PAGE>
 
  Portfolio Expenses

  General and administrative expenses primarily consist of real estate
appraisal, legal, printing, accounting and servicing agent fees.  These expenses
increased approximately $8,000, or 9% between the first nine months of 1996 and
1997, primarily due to increases in accounting fees and state franchise taxes,
partially offset by a decrease in appraisal fees.

  The Partnership management fee is 9% of distributable cash flow from
operations after any increase or decrease in working capital reserves as
determined by the managing general partner.  Management fees increased between
the two nine-month periods due to the increase in distributable cash flow.
<PAGE>
 
                       COPLEY REALTY INCOME PARTNERS 3;
                             A LIMITED PARTNERSHIP

                                   FORM 10-Q

                     FOR QUARTER ENDED SEPTEMBER 30, 1997

                                    PART II

                               OTHER INFORMATION



Items 1-5   Not Applicable

Item 6.     Exhibits and Reports on Form 8-K

            a.  Exhibits:   (27) Financial Data Schedule

            b.  Reports on Form 8-K: On July 29, 1997, the Partnership filed one
                current report on Form 8-K disclosing the sale of the South Bay
                property on July 22, 1997.
<PAGE>
 
                                  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.



                             COPLEY REALTY INCOME PARTNERS 3; A LIMITED
                             PARTNERSHIP
                             (Registrant)


November 14, 1997
                              /s/ James J. Finnegan
                              -------------------------------
                                James J. Finnegan
                                Vice President
                                of Managing General Partner,
                                Third Income Corp.



November 14, 1997
                             /s/ Karin J. Lagerlund
                             --------------------------------
                               Karin J. Lagerlund
                               Principal Financial and Accounting
                               Officer of Managing General Partner,
                               Third Income Corp.