CAPITAL REALTY INVESTORS 85 LTD PARTNERSHIP, 10-Q, 1997-10-23

CAPITAL REALTY INVESTORS 85 LTD PARTNERSHIP
10-Q, 1997-10-23
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 September 30, 1997
------------------

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 September 30, 1997
- -------------------------- ---------------------------------------
(Not applicable) (Not applicable)
<PAGE>
CAPITAL REALTY INVESTORS-85 LIMITED PARTNERSHIP

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 1997

Page
----

PART I. Financial Information (Unaudited)

Item 1. Financial Statements

Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996 . . . . . . . . . . . . . . . . 1

Consolidated Statements of Operations - for the
three and nine months ended September 30, 1997
and 1996 . . . . . . . . . . . . . . . . . . . . 2

Consolidated Statements of Cash Flows - for the
nine months ended September 30, 1997 and 1996 . . 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 . . . . . . . . . . 16

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>
September 30, December 31,
1997 1996
------------- ------------
(Unaudited)
<S> <C> <C>
Investments in and advances to partnerships $ 500,784 $ 707,182
Investment in partnership held for sale -- 1,303,669
Cash and cash equivalents 1,844,997 1,266,939
Acquisition fees, principally paid to related parties, net of
accumulated amortization of $114,673 and $141,860,
respectively 183,228 190,677
Property purchase costs, net of accumulated amortization of
$115,420 and $149,703, respectively 179,268 186,635
Other assets 6,146 4,524
------------- -------------

Total assets $ 2,714,423 $ 3,659,626
============= =============

LIABILITIES AND PARTNERS' DEFICIT

Due on investments in partnerships $ 2,522,600 $ 4,022,600
Accrued interest payable 5,271,986 7,116,193
Accounts payable and accrued expenses 63,414 49,603
------------- -------------
Total liabilities 7,858,000 11,188,396
------------- -------------
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 (23,777,542) (26,162,735)
------------- -------------
Total partners' deficit (5,143,577) (7,528,770)
------------- -------------
Total liabilities and partners' deficit $ 2,714,423 $ 3,659,626
============= =============
</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 nine months ended
September 30, September 30,
---------------------------- ----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Share of income (loss) from partnerships $ 144,667 $ (58,486) $ 437,752 $ 286,816
------------ ------------ ------------ ------------
Other revenue and expenses:
Revenue:
Interest and other income 22,859 22,402 113,551 62,287
------------ ------------ ------------ ------------
Expenses:
Interest 223,215 238,145 686,721 714,846
General and administrative 18,058 37,545 71,217 117,268
Management fee 24,482 24,482 73,447 73,447
Professional fees 12,214 22,938 47,169 75,219
Amortization 4,939 4,939 14,816 14,817
------------ ------------ ------------ ------------
282,908 328,049 893,370 995,597
------------ ------------ ------------ ------------
Total other revenue and expenses (260,049) (305,647) (779,819) (933,310)
------------ ------------ ------------ ------------

Net loss before extraordinary gain on disposition
of investment in partnership or forgiveness
of accrued interest (115,382) (364,133) (342,067) (646,494)

Extraordinary gain on disposition of investment
in partnership or forgiveness of accrued interest -- -- 2,727,260 1,472,332
------------ ------------ ------------ ------------
Net (loss) income (115,382) (364,133) 2,385,193 825,838

Accumulated losses, beginning of period (23,662,160) (25,505,304) (26,162,735) (26,695,275)
------------ ------------ ------------ ------------
Accumulated losses, end of period $(23,777,542) $(25,869,437) $(23,777,542) $(25,869,437)
============ ============ ============ ============
(Loss) income allocated to General Partners (1.51%) $ (1,743) $ (5,498) $ 36,016 $ 12,470
============ ============ ============ ============
(Loss) income allocated to Initial and Special
Limited Partners (2.49%) $ (2,873) $ (9,067) $ 59,391 $ 20,563
============ ============ ============ ============
(Loss) income allocated to BAC Holders (96%) $ (110,767) $ (349,568) $ 2,289,785 $ 792,804
============ ============ ============ ============
(Loss) income per BAC based on 21,195 BACs
outstanding $ (5.23) $ (16.48) $ 108.03 $ 37.41
============ ============ ============ ============
</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 nine months ended
September 30,
----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,385,193 $ 825,838

Adjustments to reconcile net income to net cash used in operating
activities:
Share of income from partnerships (437,752) (286,816)
Increase in accrued interest receivable on advances to
partnerships (17,719) (15,880)
Amortization of deferred costs 14,816 14,817
Payment of purchase money note interest (122,888) --
Extraordinary gain on disposition of investment in partnership (2,727,260) (1,472,332)

Changes in assets and liabilities:
(Increase) decrease in other assets (1,622) 3,159
Increase in accrued interest payable 686,721 714,847
Increase in accounts payable and accrued expenses 13,811 23,380
------------ ------------
Net cash used in operating activities (206,700) (192,987)
------------ ------------
Cash flows from investing activities:
Receipt of distributions from partnerships 528,558 335,539
Repayment of advances to partnerships 256,200 181,892
Investments in and advances to partnerships -- (122,201)
------------ ------------
Net cash provided by investing activities 784,758 395,230
------------ ------------

Net increase in cash and cash equivalents 578,058 202,243

Cash and cash equivalents, beginning of period 1,266,939 1,151,683
------------ ------------
Cash and cash equivalents, end of period $ 1,844,997 $ 1,353,926
============ ============

</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 September 30, 1997 and December 31, 1996 and its consolidated
results of operations for the three and nine months ended September 30, 1997 and
1996 and its consolidated cash flows for the nine months ended September 30,
1997 and 1996.

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 thereto
included in the Partnership's Annual Report filed on Form 10-K for the year
ended December 31, 1996.

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS

The Partnership's obligations with respect to its investments in Local
Partnerships, in the form of purchase money notes having a principal balance of
$2,348,000 plus the accrued interest of $5,196,586 as of September 30, 1997, are
payable in full 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. Purchase money notes having a principal
balance of $250,000 and $1,250,000 matured on January 1, 1997 and February 1,
1997, respectively, and the Partnership's obligation with respect to these notes
has been satisfied, as discussed below. The remaining purchase money notes
mature from 2001 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 nine months ended September 30, 1997 was $223,215 and $686,721, respectively
and $238,145 and $714,846 for the three and nine months ended September 30,
1996, respectively. The accrued interest on the purchase money notes of
$5,196,586 and $7,040,793 as of September 30, 1997 and December 31, 1996,

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

respectively, is due on the respective maturity dates of the purchase money
notes or earlier, in some instances, if the pertinent Local Partnership has
distributable net cash flow, as defined in the relevant Local Partnership
agreements.

As of September 30, 1997 and December 31, 1996, 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. (River Place) totaling
$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 over a
two-year period. Under the terms of the agreement, the purchase money note
maturity dates were 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. Also as part of the
agreement, any future cash flow distributions received by the Partnership from
River Place were applied toward any unforgiven purchase money note interest
accrued prior to December 31, 1994. For the nine months ended September 30,
1997 and 1996, cash flow distributions of $122,888 and $0, respectively, were
paid directly by River Place to the noteholders to be applied to such interest.

On December 31, 1995, the noteholders purchased a 9.9% interest in River
Place 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 federal 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 from the
Partnership in exchange for the forgiveness of purchase money note principal and
accrued interest of $1,000,000 and $1,661,553, respectively, resulting in a net
financial statement gain and a net federal tax gain of approximately $1.5
million and approximately $2.3 million, respectively, in 1996. On February 18,
1997, certain of the noteholders holding notes with an outstanding principal and
accrued interest balance of $650,000 and $1,348,641, respectively, foreclosed on
25.73% of the Partnership's remaining 49.49% interest in River Place, resulting
in an estimated net financial statement gain of approximately $1.4 million in
1997. The federal tax gain is estimated to be approximately $1.9 million. On
February 21, 1997, the noteholders purchased the Partnership's remaining 23.76%
interest in River Place from the Partnership in exchange for the forgiveness of
purchase money note principal and accrued interest of $600,000 and $434,616,
respectively, resulting in an estimated net financial statement gain in 1997 of
approximately $468,000. The federal tax gain is estimated to be approximately
$915,000. As a result of the noteholders' purchase of the Partnership's
remaining interest in River Place, Ltd., the Partnership no longer has an
ownership interest in the Local Partnership. In accordance with the purchase
option agreement, CRHC, Inc., an affiliate of the Managing General Partner, has
transferred its .01% general partner interest in River Place, Ltd. to the
noteholders and/or their assignees. Pursuant to the agreement, the noteholders
or an affiliate paid a fee into escrow to the Partnership of $35,000. This fee

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

plus interest accrued thereon totaling $1,353 was released to the Partnership in
accordance with the agreement with the noteholders, on March 17, 1997.

The Partnership's investment in River Place represented approximately 0%
and 36% of the Partnership's total assets as of September 30, 1997 and December
31, 1996, respectively. In addition, for the nine months ended September 30,
1997 and 1996, distributions from River Place, Ltd. represented approximately
23% and 0%, respectively, of total distributions from Local Partnerships.
During 1997 and 1996, 100% of the distributions from River Place were paid
directly to the purchase money note holders. The Partnership's share of income
(loss) from River Place was approximately $0 and $23,000 for the three and nine
months ended September 30, 1997, respectively, and $(7,373) and $42,105 for the
three and nine months ended September 30, 1996.

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 $371,464, respectively. As of October 23, 1997,
principal and accrued interest totaling $230,000 and $479,434, respectively,
were due. The Managing General Partner made an offer to the noteholders to
extend the maturity dates to coincide with the completion of the property's
nine-year mortgage provisional workout agreement on May 31, 2003. The
noteholders rejected the offer and, on March 28, 1996, proposed a one-year
extension. The Managing General Partner has subsequently made a counter-offer
for a nine-year extension, and as of October 23, 1997, the Managing General
Partner is awaiting a response from the purchase money note holders. There is
no assurance that the Managing General Partner will reach an agreement of any
kind with the noteholders. Additionally, the holder of a loan secured by the
mortgage on Paradise Foothills has purported to terminate the provisional
workout agreement related to the property. The Managing General Partner is
disputing the purported termination, and as of October 23, 1997, the parties are
discussing a resolution. Should the noteholders or the mortgagee begin
foreclosure proceedings on the Partnership's interest in the related Local
Partnership, the Partnership intends to vigorously defend such action. 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.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

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. On February, 27, 1996, prior to any motion
on these hearings, Deerfield entered into a term sheet agreement with the new
mortgagee pursuant to which Deerfield transferred management of the property to
the new mortgagee on April 1, 1996. Additionally, pursuant to the term sheet
agreement, Deerfield agreed, at the new mortgagee's election, to either
voluntarily transfer ownership of the property to the new mortgagee, or not
oppose a foreclosure action, no earlier than January 6, 1997, without further
consideration, if the mortgage loan default had not been cured by that date. 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. On January 7, 1997, in accordance with the term sheet
agreement, the new mortgagee foreclosed on the property.

All net cash flow generated by Deerfield prior to the foreclosure was
applied toward outstanding accrued interest on the defaulted first mortgage
loan. On April 25, 1996, the Partnership received $81,736 which represented the
release of the operating account for the Local Partnership.

The Partnership defaulted on its purchase money notes relating to Deerfield
when the notes matured on January 1, 1997 and were not paid. The default amount
included principal and accrued interest of $250,000 and $623,068, respectively.
Since the purchase money notes are nonrecourse and secured solely by the
Partnership's interest in the related Local Partnership, the Partnership's
obligation regarding the purchase money note was retired in conjunction with the
transfer of ownership in Deerfield to the new mortgagee. 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.
As a result of the foreclosure on the Deerfield property, the Partnership's
purchase money note obligation was forgiven and resulted in an estimated net
financial statement gain of approximately $875,000. The federal tax gain is
estimated to be approximately $3.1 million.

During prior years, the Partnership loaned a total of $199,087 to Deerfield
to fund operating deficits. For financial statement purposes, these loans have
been reduced to zero as they were deemed uncollectible. During 1996, the
Partnership received net payments from Deerfield on these advances of $71,405.
As these payments were in excess of the Partnership's investment in Deerfield,
they were included as income from partnerships during 1996. The Partnership
does not anticipate further payment from Deerfield due to the transfer of the
property to the new mortgagee.

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 September 30, 1997 and December 31, 1996,
accrued interest was $239,907 and $222,188, respectively.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued

Effective July 1, 1993, the maturity date of 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 9.63%, up
from a fixed annual percentage rate of 6.88% on the old mortgage loan. The
Partnership made advances to Springfield through February 1994 related to the
old mortgage. Additionally, on April 30, 1996, the Partnership loaned $64,000
to Springfield for a good faith deposit made in connection with the new mortgage
loan. During the nine months ended September 30, 1997 and 1996, Springfield
paid $256,200 and $123,690 to the Partnership as repayment of advances. As of
September 30, 1997 and December 31, 1996, non-interest-bearing loans to
Springfield totalled $38,349 and $294,549, respectively. There is no assurance
that Springfield will be able to repay the remaining balance of these loans.

Effective August 1, 1993, the maturity date of 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. On August 9, 1996, Devonshire closed on a 10 year mortgage loan with a
new lender. The new mortgage has a fixed annual percentage rate of 9.31%, up
from a fixed annual percentage rate of 6.74% on the old mortgage loan. 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 September 30, 1996,
Devonshire had repaid this loan from the Partnership in full.

The following are combined statements of operations for the six and eight
Local Partnerships in which the Partnership had invested as of September 30,
1997 and 1996, respectively. The 1997 financial statements contain information
for River Place and Deerfield through the respective dates of sale and
foreclosure. 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)

<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
----------------------------- -----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Rental revenue $ 1,976,221 $ 2,395,854 $ 6,133,165 $ 7,161,153
Other 97,031 113,313 300,002 330,180
------------ ------------ ------------ ------------
2,073,252 2,509,167 6,433,167 7,491,333
------------ ------------ ------------ ------------

Expenses:
Operating 977,013 1,464,558 3,057,783 3,888,225
Interest 733,846 827,639 2,229,498 2,482,924
Depreciation and amortization 361,284 448,586 1,114,904 1,345,761
------------ ------------ ------------ ------------
2,072,143 2,740,783 6,402,185 7,716,910
------------ ------------ ------------ ------------
Net income (loss) $ 1,109 $ (231,616) $ 30,982 $ (225,577)
============ ============ ============ ============
</TABLE>

As of September 30, 1997 and December 31, 1996, the Partnership's share of
cumulative losses to date for two of the six and five of the eight Local
Partnerships, respectively, exceeds the amount of the Partnership's investments
in and advances to those Local Partnerships by $7,508,095 and $7,074,859,
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. The Partnership paid $13,083 and $47,265 for the
three and nine months ended September 30, 1997, respectively and $33,213 and
$99,754 for the three and nine months ended September 30, 1996, 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, in accordance with the terms of the
Partnership Agreement, the Partnership is obligated to pay an annual incentive
management fee (the Management Fee) after all other expenses of the Partnership
are paid. The Partnership paid the Managing General Partner a Management Fee of
$24,482 and $73,447 for the three and nine months, ended September 30, 1997 and
1996, respectively.

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

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 $1,844,997
and $1,266,939 as of September 30, 1997 and December 31, 1996, respectively,
along with future cash distributions from Local Partnerships, is expected to
meet its current and anticipated operating cash needs. As of October 20, 1997,
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. Also as part of the
agreement, any future cash flow distributions received by the Partnership from
River Place were applied toward any unforgiven purchase money note interest
accrued prior to December 31, 1994. For the nine months ended September 30,
1997 and 1996, cash flow distributions of $122,888 and $0, respectively, were
paid directly by River Place to the noteholders to be applied to such interest.

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

were due. The Managing General Partner made an offer to the noteholders to
extend the maturity dates to coincide with the completion of the property's
nine-year mortgage provisional workout agreement on May 31, 2003. The
noteholders rejected the offer and, on March 28, 1996, proposed a one-year
extension. The Managing General Partner has subsequently made a counter-offer
for a nine-year extension, and as of October 23, 1997, the Managing General
Partner is awaiting a response from the purchase money note holders. There is
no assurance that the Managing General Partner will reach an agreement of any
kind with the noteholders. Additionally, the holder of a loan secured by the
mortgage on Paradise Foothills has purported to terminate the provisional
workout agreement related to the property. The Managing General Partner is
disputing the purported termination, and as of October 23, 1997, the parties are
discussing a resolution. Should the noteholders or the mortgagee begin
foreclosure proceedings on the Partnership's interest in the related Local
Partnership, the Partnership intends to vigorously defend such action. 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. After continuous negotiations between
the Local Partnership and HUD, HUD notified Deerfield that it 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. On February, 27, 1996, prior to any motion
on these hearings, Deerfield entered into a term sheet agreement with the new
mortgagee pursuant to which Deerfield transferred management of the property to
the new mortgagee on April 1, 1996. Additionally, pursuant to the term sheet
agreement, Deerfield agreed, at the new mortgagee's election, to either
voluntarily transfer ownership of the property to the new mortgagee, or not
oppose a foreclosure action, no earlier than January 6, 1997, without further
consideration, if the mortgage loan default had not been cured by that date. 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. On January 7, 1997, in accordance with the term sheet
agreement, the new mortgagee foreclosed on the property.

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

The Partnership closely monitors its cash flow and liquidity position in an
effort to ensure that sufficient cash is available for operating requirements.
During the nine months ended September 30, 1997, the receipt of distributions
from Local Partnerships and repayment of advances to partnerships were adequate
to support operating requirements.

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

The Partnership's net loss for the three months ended September 30, 1997
decreased from the corresponding period in 1996 primarily due to an increase in
the share of income from partnerships principally due to lower operating costs
at one property during the third quarter of 1997. Contributing to the decrease
in the Partnership's net loss was a decrease in general and administrative
expenses due to decreased payroll costs.

The Partnership's net income for the nine months ended September 30, 1997
increased from the corresponding period during 1996 primarily due to an increase
in the extraordinary gain on disposition of investment or forgiveness of accrued
interest related to the sale and foreclosure of the Partnership's remaining
interest in River Place and Deerfield, as discussed above. Contributing to the
increase in the Partnership's net income was an increase in share of income from
partnerships principally due to increased rental income at one property
resulting from increased occupancy. Also contributing to the increase in the
Partnership's net income was an increase in interest and other income primarily
due to the receipt of cash previously held in escrow related to River Place, a

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

decrease in general and administrative expenses, as discussed above, a decrease
in interest expense due to forgiveness of debt related to the sale and
foreclosure of River Place and Deerfield, as discussed above, and a decrease in
professional fees due to legal costs incurred during 1996 associated with the
Deerfield bankruptcy proceedings.

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 nine months
ended September 30, 1997 did not include losses of $144,412 and $433,236,
respectively, compared to excluded losses of $159,117 and $477,342 for the three
and nine months ended September 30, 1996, respectively.

PART II. OTHER INFORMATION
-----------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------

-14-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - Continued
-------------------------------

principal and accrued interest totaling $230,000 and $479,434, respectively,
were due. The Managing General Partner made an offer to the noteholders to
extend the maturity dates to coincide with the completion of the property's
nine-year mortgage provisional workout agreement on May 31, 2003. The
noteholders rejected the offer and, on March 28, 1996, proposed a one-year
extension. The Managing General Partner has subsequently made a counter-offer
for a nine-year extension, and as of October 23, 1997, the Managing General
Partner is awaiting a response from the purchase money note holders. There is
no assurance that the Managing General Partner will reach an agreement of any
kind with the noteholders. Additionally, the holder of a loan secured by the
mortgage on Paradise Foothills has purported to terminate the provisional
workout agreement related to the property. The Managing General Partner is
disputing the purported termination, and as of October 23, 1997, the parties are
discussing a resolution. Should the noteholders or the mortgagee begin
foreclosure proceedings on the Partnership's interest in the related Local
Partnership, the Partnership intends to vigorously defend such action. 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 September 30, 1997.

All other items are not applicable.

-15-
<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

October 23, 1997 By: /s/ Michael J. Tuszka
- --------------------------- ---------------------------------
Date Michael J. Tuszka
Vice President/Chief Accounting
Officer

Signing on behalf of the
Registrant and as Principal
Financial and Principal
Accounting Officer

-16-
<PAGE>

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

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

27 Financial Data Schedule Filed herewith electronically

-17-

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

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,844,997
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,714,423
<CURRENT-LIABILITIES> 0
<BONDS> 7,794,586
0
0
<COMMON> 0
<OTHER-SE> (5,143,577)
<TOTAL-LIABILITY-AND-EQUITY> 2,714,423
<SALES> 0
<TOTAL-REVENUES> 551,303
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 206,649
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 686,721
<INCOME-PRETAX> (342,067)
<INCOME-TAX> 0
<INCOME-CONTINUING> (342,067)
<DISCONTINUED> 0
<EXTRAORDINARY> 2,727,260
<CHANGES> 0
<NET-INCOME> 2,385,193
<EPS-PRIMARY> 108.03
<EPS-DILUTED> 108.03

</TABLE>