CAPITAL REALTY INVESTORS 85 LTD PARTNERSHIP, 10-Q, 1996-08-05

CAPITAL REALTY INVESTORS 85 LTD PARTNERSHIP
10-Q, 1996-08-05
REAL ESTATE

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<PAGE>
FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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

For the Quarter Ended June 30, 1996
-------------

Commission file number 0-23766
--------------

CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP
--------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Maryland 52-1388957
- ------------------------------------ ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

11200 Rockville Pike, Rockville, Maryland 20852
- ----------------------------------------- ------------------------
(Address of principal executive offices) (Zip Code)

(301) 468-9200
--------------------------------------------------------------------------
(Registrant's telephone number, including area code)

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 and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

Class Outstanding at June 30, 1996
- -------------------------- --------------------------------------
(Not applicable) (Not applicable)
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 1996

Page
----

PART I. Financial Information (Unaudited)

Item 1. Financial Statements

Consolidated Balance Sheets - June 30, 1996 and
December 31, 1995 . . . . . . . . . . . . . . . . 1

Consolidated Statements of Operations - for the
three and six months ended June 30, 1996 and 1995 2

Consolidated Statements of Cash Flows - for the
six months ended June 30, 1996 and 1995 . . . . . 3

Notes to Consolidated Financial Statements . . . . 4

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

PART II. Other Information

Item 3. Defaults Upon Senior Securities . . . . . . . . . . 17

Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . 17

Signature . . . . . . . . . . . . . . . . . . . . . . . . . 18

Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . 19
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------

CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

CONSOLIDATED BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
------------- ------------
(Unaudited)
<S> <C> <C>
Investments in and advances to partnerships $ 984,313 $ 826,468
Investment in partnership held for sale 1,535,703 2,675,447
Cash and cash equivalents 1,165,942 1,151,683
Acquisition fees, principally paid to related parties, net of
accumulated amortization of $136,894 and $131,928,
respectively 195,643 200,609
Property purchase costs, net of accumulated amortization of
$144,791 and $139,879, respectively 191,547 196,459
Other assets 1,968 3,344
------------- ------------

Total assets $ 4,075,116 $ 5,054,010
============= ============

LIABILITIES AND PARTNERS' DEFICIT

Due on investments in partnerships $ 4,022,600 $ 5,022,600
Accrued interest payable 6,829,292 8,014,144
Accounts payable and accrued expenses 94,563 78,576
------------- ------------
Total liabilities 10,946,455 13,115,320
------------- ------------
Commitments and contingencies

Partners' capital (deficit):

Capital paid-in:
General Partners 2,000 2,000
Limited Partners 21,202,500 21,202,500
------------- ------------
21,204,500 21,204,500

Less:
Offering costs (2,570,535) (2,570,535)
Accumulated losses (25,505,304) (26,695,275)
------------- ------------
Total partners' deficit (6,871,339) (8,061,310)
------------- ------------
Total liabilities and partners' deficit $ 4,075,116 $ 5,054,010
============= ============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

- 1 -
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------

CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)
<TABLE>
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
---------------------------- ----------------------------
1996 1995 1996 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Share of income from partnerships $ 166,913 $ 78,091 $ 345,302 $ 141,491
------------ ------------ ------------ ------------
Other revenue and expenses:
Revenue:
Interest income 20,617 27,620 39,885 52,848
------------ ------------ ------------ ------------
Expenses:
Interest 238,145 396,791 476,701 785,120
General and administrative 44,669 25,220 79,723 54,402
Management fee 24,483 24,483 48,965 48,965
Professional fees 34,690 14,587 52,281 31,319
Amortization 4,939 7,001 9,878 14,002
------------ ------------ ------------ ------------
346,926 468,082 667,548 933,808
------------ ------------ ------------ ------------
Total other revenue and expenses (326,309) (440,462) (627,663) (880,960)
------------ ------------ ------------ ------------

Loss before extraordinary gain on disposition
of investment in partnership (159,396) (362,371) (282,361) (739,469)

Extraordinary gain on disposition of investment
in partnership -- -- 1,472,332 --
------------ ------------ ------------ ------------
Net (Loss) Income (159,396) (362,371) 1,189,971 (739,469)

Accumulated losses, beginning of period (25,345,908) (26,460,718) (26,695,275) (26,083,620)
------------ ------------ ------------ ------------
Accumulated losses, end of period $(25,505,304) $(26,823,089) $(25,505,304) $(26,823,089)
============ ============ ============ ============
(Loss) income allocated to General Partners (1.51%) $ (2,406) $ (5,472) $ 17,969 $ (11,166)
============ ============ ============ ============
(Loss) income allocated to Initial and Special
Limited Partners (2.49%) $ (3,969) $ (9,023) $ 29,630 $ (18,413)
============ ============ ============ ============
(Loss) income allocated to BAC Holders (96%) $ (153,021) $ (347,876) $ 1,142,372 $ (709,890)
============ ============ ============ ============
(Loss) income per BAC based on 21,200 BACs
outstanding $ (7.21) $ (16.41) $ 53.89 $ (33.49)
============ ============ ============ ============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

- 2 -
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------

CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

For the six months ended
June 30,
----------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,189,971 $ (739,469)

Adjustments to reconcile net loss to net cash used in operating
activities:
Share of income from partnerships (345,302) (141,491)
Increase in accrued interest receivable on advances to
partnerships (9,974) (11,813)
Amortization of deferred costs 9,878 14,002
Payment of purchase money note interest -- (19,066)
Extraordinary gain on disposition of investment in partnership (1,472,332) --
Changes in assets and liabilities:
Decrease (increase) in other assets 1,376 (2,427)
Increase in accrued interest payable 476,701 785,120
Increase in accounts payable and accrued expenses 15,987 3,058
------------ ------------
Net cash used in operating activities (133,695) (112,086)
------------ ------------
Cash flows from investing activities:
Increase in escrow and cash reserves -- (12,389)
Receipt of distributions from partnerships 151,961 196,834
Repayment of advances to partnerships 118,194 131,699
Investments in and advances to partnership (122,201) --
------------ ------------
Net cash provided by investing activities 147,954 316,144
------------ ------------
Net increase in cash and cash equivalents 14,259 204,058

Cash and cash equivalents, beginning of period 1,151,683 876,995
------------ ------------
Cash and cash equivalents, end of period $ 1,165,942 $ 1,081,053
============ ============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

- 3 -
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

In the opinion of C.R.I., Inc. (CRI), the Managing General Partner, the
accompanying unaudited consolidated financial statements contain all adjustments
of a normal recurring nature necessary to present fairly the consolidated
financial position of Capital Realty Investors-85 Limited Partnership (the
Partnership) as of June 30, 1996 and December 31, 1995 and its consolidated
results of operations for the three and six months ended June 30, 1996 and 1995
and its consolidated cash flows for the six months ended June 30, 1996 and 1995.

These unaudited financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in consolidated financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. While the Managing General Partner believes that
the disclosures presented are adequate to make the information not misleading,
it is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and the notes included in
the Partnership's Annual Report filed on Form 10-K for the year ended
December 31, 1995.

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS

As of June 30, 1996, the Partnership's obligations with respect to its
investments in Local Partnerships, in the form of purchase money notes of
$3,848,000 plus the accrued interest of $6,753,892, are payable upon the
earliest of: (i) sale or refinancing of the respective Local Partnership's
rental property; (ii) payment in full of the respective Local Partnership's
permanent loan; or (iii) maturity. Purchase money notes in an aggregate
principal amount of $230,000 matured on January 30, 1996 but have not been paid,
as discussed below. The remaining purchase money notes mature from 1997 to
2003. The purchase money notes are generally secured by the Partnership's
interest in the respective Local Partnership. There is no assurance that the
underlying properties will have sufficient appreciation and equity to enable the
Partnership to pay the purchase money notes' principal and accrued interest when
due. If a purchase money note is not paid in accordance with its terms, the
Partnership will either have to renegotiate the terms of repayment or risk
losing its partnership interest in the Local Partnership. The Managing General
Partner is continuing to investigate possible alternatives to reduce the
Partnership's long-term debt obligations. These alternatives include, among
others, retaining the cash available for distribution to meet the purchase money
note requirements, buying out certain purchase money notes at a discounted
price, extending the due dates of certain purchase money notes, or refinancing
the respective properties' underlying debt and using the Partnership's share of
the proceeds to pay off or buy down certain purchase money note obligations.

Interest expense on the Partnership's purchase money notes for the three
and six months ended June 30, 1996 was $238,145 and $476,701, respectively, and
for the three and six months ended June 30, 1995 was $396,791 and $785,120,
respectively. The accrued interest on the purchase money notes of $6,753,892
and $7,938,744 as of June 30, 1996 and December 31, 1995, respectively, is due
on the respective maturity dates of the purchase money notes or earlier if the
Local Partnerships have distributable net cash flow, as defined in the relevant
Local Partnership agreements.

-4-
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

As of June 30, 1996 and December 31, 1995, the Partnership's obligations
with respect to its investments in Local Partnerships included $174,600 due to
local general partners, plus accrued interest on these obligations of $75,400.

Purchase money notes relating to River Place, Ltd. totalling $2,500,000
plus accrued interest were originally scheduled to mature on December 31, 1995.
On December 27, 1995, the Managing General Partner entered into an agreement
with the noteholders which granted the noteholders three options to purchase the
Partnership's 98.99% limited partner interest in River Place, Ltd. over a two-
year period. Under the terms of the agreement, the purchase money note maturity
dates have been extended to February 1, 1997, with interest to accrue from
January 1, 1996 to February 1, 1997 at the Applicable Federal Rate for short-
term obligations in effect at January 1, 1996 (5.65%), compounded annually.
Purchase money note interest of $821,528 which accrued during 1995 has been
forgiven by the noteholders as part of the agreement. On December 31, 1995, the
noteholders purchased a 9.9% interest in River Place, Ltd. from the Partnership
in exchange for the forgiveness of purchase money note principal and accrued
interest of $250,000 and $306,015, respectively, resulting in a net financial
statement gain and a net tax gain of $258,957 and $470,855, respectively, in
1995. On January 2, 1996, the noteholders purchased an additional 39.6%
interest in River Place, Ltd. from the Partnership in exchange for the
forgiveness of purchase money note principal and accrued interest of $1,000,000
and $1,661,542, respectively, resulting in a net financial statement gain and a
net tax gain of $1,472,332 and $2,320,873, respectively, in 1996. The
noteholders have one additional option remaining as part of the agreement,
pursuant to which they may purchase the Partnership's remaining interest in
River Place, Ltd. in exchange for the forgiveness of the remaining purchase
money note principal in the aggregate amount of $1,250,000, plus the related
accrued interest. The remaining option must be exercised, if at all, between
February 3, 1997 and March 1, 1997. If the noteholders exercise their final
option prior to its expiration, the Partnership would no longer have an
ownership interest in the Local Partnership, and in accordance with the purchase
option agreement, CRHC, Inc., an affiliate of the Managing General Partner,
would transfer its .01% general partner interest in River Place, Ltd. to the
noteholders and/or their assignees. Also as part of the agreement, any future
cash flow distributions received by the Partnership from River Place, Ltd. will
be applied towards any unforgiven purchase money note interest accrued prior to
December 31, 1994. Pursuant to the agreement, the noteholders or an affiliate
will pay a fee into escrow to the Partnership of $35,000, which will be released
to the Partnership upon the execution or expiration of the final option by the
noteholders. There is no assurance that the noteholders will exercise the final
option prior to its expiration date. The investment in River Place, Ltd.
represented approximately 61% and 76% of the Partnership's investments in and
advances to Local Partnerships as of June 30, 1996 and December 31, 1995,
respectively. In addition, for the six months ended June 30, 1996 and 1995,
distributions from River Place, Ltd. represented approximately 0% and 85%,
respectively, of total distributions from Local Partnerships. The Partnership's
share of income from River Place, Ltd. represented approximately 14% of the
total share of income recognized from Local Partnerships for the three and six
months ended June 30, 1996, respectively, and 100% and 86% for the three and six
months ended June 30, 1995, respectively.

The Partnership defaulted on its purchase money notes relating to Paradise
Associates, L.P. (Paradise Foothills), when the notes matured on January 30,

-5-
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

1996 and were not paid. The default amount included principal and accrued
interest of $230,000 and $371,288, respectively. As of August 5, 1996,
principal and accrued interest totalling $230,000 and $402,189, respectively,
were due. The Managing General Partner had made an offer to the noteholders to
extend the maturity dates to coincide with the completion of the property's
nine-year mortgage workout agreement on May 31, 2003. The noteholders rejected
the offer and, on March 28, 1996, proposed a one-year extension. As of August
5, 1996, the Managing General Partner is negotiating the terms of the agreement.
There is no assurance that the Managing General Partner will reach an agreement
of any kind with the noteholders. Should the noteholders begin foreclosure
proceedings on the Partnerships interest in the related local partnership, the
Partnership intends to vigorously defend any action by the noteholders.
However, there can be no assurance that the Partnership will be able to retain
its interest in the Local Partnership. The uncertainty about the continued
ownership of the Partnership's interest in the related Local Partnership does
not impact the Partnership's financial condition because the related purchase
money note is nonrecourse and secured solely by the Partnership's interest in
the Local Partnership. Therefore, should the investment in Paradise Foothills
not produce sufficient value to satisfy the purchase money note related to
Paradise Foothills, the Partnership's exposure to loss is limited since the
amount of the nonrecourse indebtedness exceeds the carrying amount of the
investment in and advances to the Local Partnership. Thus, even a complete loss
of this investment would not have a material impact on the operations of the
Partnership.

Deerfield Partners Limited Partnership (Deerfield) was unable to generate
sufficient cash flow to pay its debt service and therefore was unable to meet
its obligations under the terms of the loan documents. The Local Partnership
defaulted on its mortgage loan in 1990, and after negotiations with the
Department of Housing and Urban Development (HUD), submitted a one-year workout
proposal to the local HUD office, effective May 1, 1991, to which HUD did not
respond. On July 1, 1992, a second one-year workout proposal was submitted,
effective September 1, 1992, to which HUD did not respond. On September 17,
1993, a six-year workout proposal, effective October 1, 1993, was submitted in
accordance with HUD's new workout guidelines. At HUD's request, a nine-year
workout proposal was submitted to HUD on April 15, 1994. This proposal was
rejected by HUD. A new nine-year workout proposal was submitted to HUD on May
31, 1995. HUD rejected this proposal and notified Deerfield that HUD had
offered its mortgage loan for sale in September 1995. A new mortgagee purchased
the loan from HUD on November 16, 1995. On November 16, 1995, the Local
Partnership received a notice of default, acceleration and assignment of rents
from the new mortgagee. The new mortgagee was scheduled to foreclose on the
property on December 21, 1995. In order to protect its assets, the Local
Partnership filed for bankruptcy protection under Chapter 11 in the State of
Maryland on December 20, 1995. The new mortgagee filed motions with the
bankruptcy court for dismissal and for relief from stay. A hearing on these
motions was originally scheduled for January 23, 1996, however, a continuance
was granted as the Local Partnership and the new mortgagee discussed settlement
options. On February 27, 1996, Deerfield entered into a term sheet agreement
with the new mortgagee pursuant to which Deerfield transferred management and
control of the property to the new mortgagee on April 1, 1996, and, at the new
mortgagee's election, will voluntarily transfer ownership of the property to the
new mortgagee no earlier than January 6, 1997, without further consideration.
On March 20, 1996, the bankruptcy court dismissed the bankruptcy case, with the

-6-
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

acquiescence of the Local Partnership, subject to the provisions of the term
sheet agreement. Any and all future net cash flow generated by the property
prior to the transfer of ownership will be applied towards outstanding accrued
interest on the defaulted first mortgage loan. On April 25, 1996, the
Partnership received $81,736 which represented the release of the reserve
account for the Local Partnership. During 1989 and 1988, the Partnership loaned
a total of $196,746 to the Local Partnership to fund operating deficits. The
Partnership advanced net funds of $2,341 and $11,202 in 1995 and 1996,
respectively, to fund operating deficits while the Local Partnership was seeking
bankruptcy protection. The Partnership does not expect to advance any
additional funds. The loans do not bear interest and repayment is due upon the
disposition of the property; however, there is no assurance that the Local
Partnership will be able to repay any loans in accordance with the terms
thereof.

The anticipated transfer of the Local Partnership's ownership of the
property does not impact the Partnership's financial condition because the
related purchase money note is nonrecourse and secured solely by the
Partnership's interest in the related Local Partnership. The Partnership's
investment in Deerfield had previously been reduced to zero as a result of
losses from the Local Partnership during prior years. Acquisition fees and
property purchase costs relating to Deerfield were fully amortized as of
December 31, 1995 in order to record the investment at its net realizable value.
Therefore, since the investment in Deerfield is not expected to produce
sufficient value to satisfy the related purchase money note, the Partnership's
exposure to loss is limited since the amount of the nonrecourse indebtedness
exceeds the carrying amount of the investment in and advances to the Local
Partnership. Thus, the complete loss of this investment will not have a
material impact on the operations of the Partnership.

Mesa Partners Limited Partnership (The Pointe), located in El Paso, Texas,
modified its mortgage loan in 1987. In connection with the loan modification,
the Partnership loaned $262,500 to the Local Partnership in 1987. Repayment of
this loan, with simple interest at 9% per annum, is expected to occur upon sale
or refinancing of the property. As of June 30, 1996 and December 31, 1995,
accrued interest was $210,376 and $200,402, respectively.

Effective July 1, 1993, the Springfield Apartments (Springfield) first
mortgage loan was extended to June 30, 1996. Springfield received a 30-day
extension, thereby extending the mortgage loan to July 30, 1996. On July 17,
1996, Springfield closed on a 10 year mortgage loan with a new lender. The new
mortgage has a fixed annual percentage rate of 9.68%, up from a fixed annual
percentage rate of 6.88% on the old mortgage loan. Under the old mortgage, debt
service was due to the lender on the first day of each month with no "grace
period" and substantial late payment penalties. Therefore, prior to February
1994, the Partnership had advanced approximately $65,000 per month to
Springfield in the form of a bridge loan which was to be repaid by the fifteenth
of the following month. The February 1994 advance to Springfield was held by
the Local Partnership to establish a one-month debt service reserve to eliminate
the need for a monthly bridge loan from the Partnership. Springfield began
repaying a portion of the non-interest-bearing advances made by the Partnership
in April 1994. During the six months ended June 30, 1996, the Partnership
received $59,992 from Springfield related to these loan advances. Additionally,
on April 30, 1996, the Partnership loaned $64,000 to Springfield for a good

-7-
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

faith deposit made in connection with the new mortgage loan. On July 17, 1996,
the Partnership received $63,698 from Springfield representing the Local
Partnership's payment to the Partnership for the good faith deposit advance. As
of June 30, 1996 and December 31, 1995, non-interest-bearing loans to
Springfield totalled $358,247 and $354,239, respectively. There is no assurance
that Springfield will be able to repay any loans in accordance with the terms.

Effective August 1, 1993, the Devonshire Apartments (Devonshire) first
mortgage loan was extended to July 31, 1996. Devonshire received a 30-day
extension, thereby extending the mortgage loan to August 31, 1996. The Local
Partnership has received a commitment to enter a 10-year mortgage and is
currently working towards settlement with a new lender. There is no assurance
that Devonshire will be able to obtain new financing upon expiration of the
mortgage loan extension. On April 30, 1996, the Partnership loaned $47,000 to
Devonshire for a good faith deposit made in connection with the new mortgage
loan. As of June 30, 1996, the Partnership had received full payment from
Devonshire related to the advance.

The Partnership has been informed by Equity Resources Group, Inc. (ERG), a
Massachusetts limited partnership and limited partner in the Partnership, that
it plans to initiate a tender offer to purchase additional BACs in the
Partnership, but in no case more than a 5% interest in the Partnership. ERG has
stated that it plans to make the offer for the express purpose of holding the
BACs as a long-term investment and not with a view to resale. ERG has not
indicated the price per BAC which it plans to offer for the BACs in the
Partnership. In the event that a tender offer is initiated, the purchase price
will be determined solely at the discretion of ERG and may not necessarily
represent the fair market value of the BACs. The General Partner takes no
position as to recommending or not recommending ERG to make an offer, nor will
it take a position as to recommending or not recommending the offer to
investors, in the event that an offer is made.

Other than the potential ERG offer, it is not anticipated that there will
be any other market for resale of BACs in the Partnership. As a result, an
investor may be unable to sell or otherwise dispose of his or her interest in
the Partnership. There is no assurance that ERG will initiate a tender offer.

The following are combined statements of operations for the Local
Partnerships in which the Partnership has invested. The statements are compiled
from information supplied by the management agents of the projects and are
unaudited.

-8-
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

COMBINED STATEMENTS OF OPERATIONS
(Unaudited)

For the three months ended For the six months ended
June 30, June 30,
----------------------------- -----------------------------
1996 1995 1996 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Rental revenue $ 2,386,895 $ 2,321,330 $ 4,765,299 $ 4,623,272
Other 105,593 115,292 216,867 228,968
------------ ------------ ------------ ------------
2,492,488 2,436,622 4,982,166 4,852,240
------------ ------------ ------------ ------------

Expenses:
Operating 1,157,008 1,195,051 2,423,667 2,384,011
Interest 827,644 979,946 1,655,285 1,959,893
Depreciation and amortization 448,588 445,615 897,175 891,231
------------ ------------ ------------ ------------
2,433,240 2,620,612 4,976,127 5,235,135
------------ ------------ ------------ ------------
Net gain (loss) $ 59,248 $ (183,990) $ 6,039 $ (382,895)
============ ============ ============ ============
</TABLE>

As of June 30, 1996 and December 31, 1995, the Partnership's share of
cumulative losses to date for five and six of the eight Local Partnerships,
respectively, exceeds the amount of the Partnership's investments in and
advances to those Local Partnerships by $6,978,199 and $6,386,262, respectively.
As the Partnership has no further obligation to advance funds or provide
financing to these Local Partnerships, the excess losses have not been reflected
in the accompanying consolidated financial statements.

3. RELATED-PARTY TRANSACTIONS

In accordance with the terms of the Partnership Agreement, the Partnership
is obligated to reimburse the Managing General Partner for its direct expenses
in managing the Partnership and to pay an annual incentive management fee (the
Management Fee) after all other expenses of the Partnership are paid. The
Partnership paid $33,313 and $66,541 for the three and six months ended June 30,
1996, respectively, and $16,984 and $36,324 for the three and six months ended
June 30, 1995, respectively, as direct reimbursement of expenses incurred on
behalf of the Partnership. Such expenses are included in the consolidated
statements of operations as general and administrative expenses. Additionally,
the Partnership paid the Managing General Partner a Management Fee of $24,483
and $48,965 for the three and six months, respectively, ended June 30, 1996 and
1995.

-9-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------

Business
--------

Capital Realty Investors-85 Limited Partnership's (the Partnership)
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains information that may be considered forward looking. This
information contains a number of risks and uncertainties, as discussed herein
and in the Partnership's Annual Report filed on Form
10-K, that could cause actual results to differ materially.

Financial Condition/Liquidity
-----------------------------

The Partnership's liquidity, with unrestricted cash resources of $1,165,942
and $1,151,683 as of June 30, 1996 and December 31, 1995, respectively, along
with future cash distributions from Local Partnerships, is expected to meet its
current and anticipated operating cash needs. The Partnership's remaining
obligations with respect to its investment in Local Partnerships of $250,000,
excluding purchase money notes and accrued interest, is not in excess of its
capital resources. As of July 26, 1996, there are no material commitments for
capital expenditures.

-10-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

January 1, 1996 to February 1, 1997 at the Applicable Federal Rate for short-
term obligations in effect at January 1, 1996 (5.65%), compounded annually.
Purchase money note interest of $821,528 which accrued during 1995 has been
forgiven by the noteholders as part of the agreement. On December 31, 1995, the
noteholders purchased a 9.9% interest in River Place, Ltd. from the Partnership
in exchange for the forgiveness of purchase money note principal and accrued
interest of $250,000 and $306,015, respectively, resulting in a net financial
statement gain and a net tax gain of $258,957 and $470,855, respectively, in
1995. On January 2, 1996, the noteholders purchased an additional 39.6%
interest in River Place, Ltd. from the Partnership in exchange for the
forgiveness of purchase money note principal and accrued interest of $1,000,000
and $1,661,542, respectively, resulting in a net financial statement gain and a
net tax gain of $1,472,332 and $2,320,873, respectively, in 1996. The
noteholders have one additional option remaining as part of the agreement,
pursuant to which they may purchase the Partnership's remaining interest in
River Place, Ltd. in exchange for the forgiveness of the remaining purchase
money note principal in the aggregate amount of $1,250,000, plus the related
accrued interest. The remaining option must be exercised, if at all, between
February 3, 1997 and March 1, 1997. If the noteholders exercise their final
option prior to its expiration, the Partnership would no longer have an
ownership interest in the Local Partnership, and in accordance with the purchase
option agreement, CRHC, Inc., an affiliate of the Managing General Partner,
would transfer its .01% general partner interest in River Place, Ltd. to the
noteholders and/or their assignees. Also as part of the agreement, any future
cash flow distributions received by the Partnership from River Place, Ltd. will
be applied towards any unforgiven purchase money note interest accrued prior to
December 31, 1994. Pursuant to the agreement, the noteholders or an affiliate
will pay a fee into escrow to the Partnership of $35,000, which will be released
to the Partnership upon the execution or expiration of the final option by the
noteholders. There is no assurance that the noteholders will exercise the final
option prior to its expiration date. The investment in River Place, Ltd.
represented approximately 61% and 76% of the Partnership's investments in and
advances to Local Partnerships as of June 30, 1996 and December 31, 1995,
respectively. In addition, for the six months ended June 30, 1996 and 1995,
distributions from River Place, Ltd. represented approximately 0% and 85%,
respectively, of total distributions from Local Partnerships. The Partnership's
share of income from River Place, Ltd. represented approximately 14% of the
total share of income recognized from Local Partnerships for the three and six
months ended June 30, 1996, respectively, and 100% and 86% for the three and six
months ended June 30, 1995, respectively.

-11-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

However, there can be no assurance that the Partnership will be able to retain
its interest in the Local Partnership. The uncertainty about the continued
ownership of the Partnership's interest in the related Local Partnership does
not impact the Partnership's financial condition because the related purchase
money note is nonrecourse and secured solely by the Partnership's interest in
the Local Partnership. Therefore, should the investment in Paradise Foothills
not produce sufficient value to satisfy the purchase money note related to
Paradise Foothills, the Partnership's exposure to loss is limited since the
amount of the nonrecourse indebtedness exceeds the carrying amount of the
investment in and advances to the Local Partnership. Thus, even a complete loss
of this investment would not have a material impact on the operations of the
Partnership.

The Partnership closely monitors its cash flow and liquidity position in an
effort to ensure that sufficient cash is available for operating requirements.
For the six months ended June 30, 1996, the receipt of distributions from Local
Partnerships was adequate to support operating cash requirements.

Results of Operations
---------------------

The Partnership's net loss for the three months ended June 30, 1996
decreased from the corresponding period in 1995 primarily due to a decrease in
interest expense as a result of the forgiveness of a portion of the purchase
money note principal in exchange for a portion of the Partnership's investment
in River Place, Ltd., as discussed above. Contributing to the decrease in net
loss was an increase in share of income from partnerships. The increase in
share of income from partnerships is as a result of decreased interest costs at
one property due to a mortgage loan refinancing during August 1995 and due to
repayment of an advance received from one Local Partnership which had previously
been written off. Partially offsetting the decrease in net loss was an increase
in professional fees due to legal costs associated with the Deerfield bankruptcy
proceedings, and increased general and administrative expenses due to increased
payroll costs.

The Partnership's net income for the six months ended June 30, 1996
increased from the corresponding period in 1995 primarily due to the
extraordinary gain on disposition of a portion of the Partnership's investment
in River Place, Ltd., as discussed above. Contributing to the increase in net
income was a decrease in interest expense and an increase in share of income
from Local Partnerships, as discussed above. Partially offsetting the increase
in net income was an increase in professional fees and general and
administrative expenses, as discussed above.

For financial reporting purposes, the Partnership, as a limited partner in
the Local Partnerships, does not record losses from the Local Partnerships in
excess of its investment to the extent that the Partnership has no further
obligation to advance funds or provide financing to the Local Partnerships. As
a result, the Partnership's recognized losses for the three and six months ended
June 30, 1996 did not include losses of $432,823 and 591,937, respectively,
compared to excluded losses of $260,584 and $521,166 for the three and six
months ended June 30, 1995, respectively.

-12-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

defaulted on its mortgage loan in 1990, and after negotiations with the
Department of Housing and Urban Development (HUD), submitted a one-year workout
proposal to the local HUD office, effective May 1, 1991, to which HUD did not
respond. On July 1, 1992, a second one-year workout proposal was submitted,
effective September 1, 1992, to which HUD did not respond. On September 17,
1993, a six-year workout proposal, effective October 1, 1993, was submitted in
accordance with HUD's new workout guidelines. At HUD's request, a nine-year
workout proposal was submitted to HUD on April 15, 1994. This proposal was
rejected by HUD. A new nine-year workout proposal was submitted to HUD on May
31, 1995. HUD rejected this proposal and notified Deerfield that HUD had
offered its mortgage loan for sale in September 1995. A new mortgagee purchased
the loan from HUD on November 16, 1995. On November 16, 1995, the Local
Partnership received a notice of default, acceleration and assignment of rents
from the new mortgagee. The new mortgagee was scheduled to foreclose on the
property on December 21, 1995. In order to protect its assets, the Local
Partnership filed for bankruptcy protection under Chapter 11 in the State of
Maryland on December 20, 1995. The new mortgagee filed motions with the
bankruptcy court for dismissal and for relief from stay. A hearing on these
motions was originally scheduled for January 23, 1996, however, a continuance
was granted as the Local Partnership and the new mortgagee discussed settlement
options. On February 27, 1996, Deerfield entered into a term sheet agreement
with the new mortgagee pursuant to which Deerfield transferred management and
control of the property to the new mortgagee on April 1, 1996, and, at the new
mortgagee's election, will voluntarily transfer ownership of the property to the
new mortgagee no earlier than January 6, 1997, without further consideration.
On March 20, 1996, the bankruptcy court dismissed the bankruptcy case, with the
acquiescence of the Local Partnership, subject to the provisions of the term
sheet agreement. Any and all future net cash flow generated by the property
prior to the transfer of ownership will be applied towards outstanding accrued
interest on the defaulted first mortgage loan. On April 25, 1996, the
Partnership received $81,736 which represented the release of the reserve
account for the Local Partnership. During 1989 and 1988, the Partnership loaned
a total of $196,746 to the Local Partnership to fund operating deficits. The
Partnership advanced net funds of $2,341 and $11,202 in 1995 and 1996,
respectively, to fund operating deficits while the Local Partnership was seeking
bankruptcy protection. The Partnership does not expect to advance any
additional funds. The loans do not bear interest and repayment is due upon the
disposition of the property; however, there is no assurance that the Local
Partnership will be able to repay any loans in accordance with the terms
thereof.

-13-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

No other significant changes in the Partnership's operations have taken
place during this period.

General
-------

-14-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

will be determined solely at the discretion of ERG and may not necessarily
represent the fair market value of the BACs. The General Partner takes no
position as to recommending or not recommending ERG to make an offer, nor will
it take a position as to recommending or not recommending the offer to
investors, in the event that an offer is made.

-15-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------

The Partnership defaulted on its purchase money notes relating to Paradise
Associates, L.P. (Paradise Foothills), when the notes matured on January 30,
1996 and were not paid. The default amount included principal and accrued
interest of $230,000 and $371,288, respectively. As of August 5, 1996,
principal and accrued interest totalling $230,000 and $402,189, respectively,
were due. The Managing General Partner had made an offer to the noteholders to
extend the maturity dates to coincide with the completion of the property's
nine-year mortgage workout agreement on May 31, 2003. The noteholders rejected
the offer and, on March 28, 1996, proposed a one-year extension. As of August
5, 1996, the Managing General Partner is negotiating the terms of the agreement.
There is no assurance that the Managing General Partner will reach an agreement
of any kind with the noteholders. Should the noteholders begin foreclosure
proceedings on the Partnerships interest in the related local partnership, the
Partnership intends to vigorously defend any action by the noteholders.
However, there can be no assurance that the Partnership will be able to retain
its interest in the Local Partnership. The uncertainty about the continued
ownership of the Partnership's interest in the related Local Partnership does
not impact the Partnership's financial condition because the related purchase
money note is nonrecourse and secured solely by the Partnership's interest in
the Local Partnership. Therefore, should the investment in Paradise Foothills
not produce sufficient value to satisfy the purchase money note related to
Paradise Foothills, the Partnership's exposure to loss is limited since the
amount of the nonrecourse indebtedness exceeds the carrying amount of the
investment in and advances to the Local Partnership. Thus, even a complete loss
of this investment would not have a material impact on the operations of the
Partnership.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------

No Reports on Form 8-K were filed with the Commission during the quarter
ended June 30, 1996.

All other items are not applicable.

-16-
<PAGE>
SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

CAPITAL REALTY INVESTORS-85
LIMITED PARTNERSHIP
(Registrant)

By: C.R.I., Inc.
Managing General Partner

August 5, 1996 By: /s/ Deborah K. Browning
- ------------------------- ---------------------------------
Date Deborah K. Browning
Vice President/Chief Accounting
Officer

Signing on behalf of the
Registrant and as Principal
Accounting Officer

-17-
<PAGE>

EXHIBIT INDEX
-------------

Exhibit Method of Filing
- ------- -----------------------------

27 Financial Data Schedule Filed herewith electronically

-18-

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE SECOND QUARTER 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH 10-Q.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 1,165,942
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4,075,116
<CURRENT-LIABILITIES> 0
<BONDS> 10,851,892
0
0
<COMMON> 0
<OTHER-SE> (6,871,339)
<TOTAL-LIABILITY-AND-EQUITY> 4,075,116
<SALES> 0
<TOTAL-REVENUES> 385,187
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 190,847
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 476,701
<INCOME-PRETAX> (282,361)
<INCOME-TAX> 0
<INCOME-CONTINUING> (282,361)
<DISCONTINUED> 0
<EXTRAORDINARY> 1,472,332
<CHANGES> 0
<NET-INCOME> 1,189,971
<EPS-PRIMARY> 53.89
<EPS-DILUTED> 53.89

</TABLE>