CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LTD PARTNERSHIP, 10-Q, 1996-05-17

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LTD PARTNERSHIP
10-Q, 1996-05-17
ASSET-BACKED SECURITIES

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<PAGE>
FORM 10-Q
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 March 31, 1996
----------------------

Commission file number 1-12034
----------------------

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP
----------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 52-1551450
- --------------------------------- -----------------------
(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

As of May 14, 1996, 5,258,268 Beneficial Assignee Certificates were
outstanding.
<PAGE>

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 1996

Page
----

PART I. Financial Information (Unaudited)

Item 1. Financial Statements

Balance Sheets - March 31, 1996 and
December 31, 1995 . . . . . . . . . . . . . . . . . 1

Statements of Income - for the three months
ended March 31, 1996 and 1995 . . . . . . . . . . . 2

Statement of Changes in Partners' Capital
(Deficit) - for the three months ended
March 31, 1996 . . . . . . . . . . . . . . . . . . . 3

Statements of Cash Flows - for the three
months ended March 31, 1996 and 1995 . . . . . . . . 4

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

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . 20

PART II. Other Information

Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . 28

Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 31

Signature . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . 33
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

BALANCE SHEETS

ASSETS

As of As of
March 31, December 31,
1996 1995
------------- ------------
(Unaudited)
<S> <C> <C>
Investment in mortgage revenue bonds $ 70,951,947 $ 70,951,947

Cash and cash equivalents 73,762 187,747
Marketable securities 1,505,994 1,213,572
Working capital reserves invested in marketable securities 4,214,873 4,235,144
Interest reserves invested in marketable securities 298,750 298,750
Receivables and other assets 46,659 46,719
------------ ------------
Total assets $ 77,091,985 $ 76,933,879
============ ============

LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)

Distributions payable $ 1,593,575 $ 1,593,577
Accounts payable and accrued expenses 410,990 393,345
------------ ------------
Total liabilities 2,004,565 1,986,922
------------ ------------

Partners' capital (deficit):
General Partner (447,144) (448,563)
Beneficial Assignee Certificates (BACs) - 5,258,268 BACs
issued and outstanding 75,534,564 75,395,520
------------ ------------
Total partners' capital 75,087,420 74,946,957
------------ ------------
Total liabilities and partners' capital $ 77,091,985 $ 76,933,879
============ ============

</TABLE>

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

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

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

STATEMENTS OF INCOME

(Unaudited)
<TABLE>
<CAPTION>

For the three months ended
March 31,
-------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Interest from mortgage revenue bonds and working capital loan $ 1,929,814 $ 1,722,828
------------ ------------
Other income (expenses):
Other interest income 58,165 69,248
Merger-related expenses (152,076) --
General and administrative (79,263) (113,909)
Professional fees (22,602) (21,619)
------------ ------------
(195,776) (66,280)
------------ ------------
Net income $ 1,734,038 $ 1,656,548
============ ============
Net income allocated to General Partner (1.01%) $ 17,514 $ 16,731
============ ============
Net income allocated to BAC Holders (98.99%) $ 1,716,524 $ 1,639,817
============ ============
Net income per BAC $ 0.33 $ 0.31
============ ============
BACs outstanding 5,258,268 5,258,268
============ ============

</TABLE>

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

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

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

STATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)

For the three months ended March 31, 1996

(Unaudited)

<TABLE>
<CAPTION>
Beneficial
Assignee
Certificate General
Holders Partner Total
------------ ---------- ------------
<S> <C> <C> <C>
Balance, December 31, 1995 $ 75,395,520 $ (448,563) $ 74,946,957

Net income 1,716,524 17,514 1,734,038

Distributions paid or accrued of $0.30 per BAC
(none of which is return of capital) (1,577,480) (16,095) (1,593,575)
------------ ---------- ------------
Balance, March 31, 1996 $ 75,534,564 $ (447,144) $ 75,087,420
============ ========== ============
</TABLE>

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

-3-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. FINANCIAL STATEMENTS
--------------------

CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

STATEMENTS OF CASH FLOWS

(Unaudited)
<TABLE>
<CAPTION>

For the three months ended
March 31,
1996 1995
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,734,038 $ 1,656,548
Adjustments to reconcile net income to net cash provided by operating
activities:
Decrease in receivables and other assets 60 17,145
Increase (decrease) in accounts payable and accrued expenses 17,645 (33,732)
------------ ------------
Net cash provided by operating activities 1,751,743 1,639,961
------------ ------------

Cash flows from investing activities:
Sale of marketable securities 1,907,578 3,233,886
Purchase of marketable securities (2,200,000) (2,673,187)
Withdrawals from (deposits to) working capital reserves invested in
marketable securities 20,271 (97,807)
Withdrawals from interest reserves invested in marketable securities -- 96,090
------------ ------------
Net cash (used in) provided by investing activities (272,151) 558,982
------------ ------------
Cash flows from financing activities:
Distributions paid to BAC Holders and General Partner (1,593,577) (2,177,886)
------------ ------------

Net (decrease) increase in cash and cash equivalents (113,985) 21,057

Cash and cash equivalents, beginning of period 187,747 100,513
------------ ------------
Cash and cash equivalents, end of period $ 73,762 $ 121,570
============ ============

</TABLE>

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

-4-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

In the opinion of CRITEF III Associates Limited Partnership (the General
Partner), the accompanying unaudited financial statements of Capital Realty
Investors Tax Exempt Fund III Limited Partnership (the Partnership) contain all
adjustments of a normal recurring nature necessary to present fairly the
Partnership's financial position as of March 31, 1996 and December 31, 1995 and
the results of its operations for the three months ended March 31, 1996 and 1995
and its cash flows for the three months ended March 31, 1996 and 1995.

These unaudited financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC). Certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles (GAAP) have
been condensed or omitted. While the General Partner believes that the
disclosures presented are adequate to make the information not misleading, it is
suggested that these financial statements be read in conjunction with the
amended and restated financial statements and notes included in the
Partnership's Annual Report filed on Form 10-K/A on May 17, 1996 for the year
ended December 31, 1995.

The financial statements for the three months ended March 31, 1995 have
been restated to conform to 1996 presentation, as well as to conform with the
restated 1995 and 1994 financial statements as discussed in Note 3.

2. MERGER PROPOSAL

On September 11, 1995, the Partnership and its General Partner entered into
a merger agreement, subject to BAC Holder approval, with an affiliate of Capital
Apartment Properties, Inc. (CAPREIT), a private real estate investment trust.
An affiliate of CAPREIT is the property manager for five of the eight properties
securing the bonds held by the Partnership. All five of the properties managed
by an affiliate of CAPREIT are presently in default with respect to their
mortgage loans held by the Partnership. If the merger proposal is approved by a
majority vote of BAC Holders, all of the BACs in the Partnership will be
redeemed for cash and the interests represented by such BACs will be canceled.
On January 31, 1996, the agreement for the proposed merger was modified for the
first time to improve the terms of the original proposal. Under the original
proposal, the redemption amount per BAC was to be $14.360. Under the first
modified agreement, the redemption amount per BAC was to be $15.1735, subject to
adjustment but not less than $15.0372 or greater than $15.3098. On March 14,
1996, the merger agreement was modified for the second time to round the
expected redemption amount per BAC from $15.1735 to $15.18, subject to
adjustment for available cash as defined in the amended merger agreement, but
not less than $15.04 or greater than $15.32. In addition, the redemption
amounts will be reduced by the amount of court approved legal fees and expenses
awarded to counsel of the plaintiffs in the putative class action suits naming
the Partnership and others, as described below. Such legal fees and expenses
are not expected to exceed $0.19 per BAC.

The BAC Holders will also vote upon the removal of the Partnership's
General Partner immediately prior to consummation of the proposed merger and the
election in its stead of a newly-formed wholly-owned subsidiary of CAPREIT.
CAPREIT has agreed to pay the General Partner $500,000 in consideration for its
1.01% general partner interest in the Partnership.

-5-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)
2. MERGER PROPOSAL - Continued

CAPREIT and/or its designee will also acquire accounts receivables held by
CRI and CRIIMI MAE Services Limited Partnership (CRIIMI), for the accrued
mortgage servicing and administration fees on certain property mortgage loans of
the Partnership. The general partner of CRIIMI is a subsidiary of CRIIMI MAE
Inc., a publicly-traded company affiliated with the General Partners. Under the
second modified agreement, CAPREIT will pay the discounted amount of $667,485 to
CRI for its fees accrued through June 30, 1995, which represents approximately
42% of the total accrued fees owed to CRI. Also, CAPREIT will pay $566,676 to
CRIIMI for its fees accrued from July 1, 1995 through June 30, 1996, which
represents 100% of the fees which are expected to be owed to CRIIMI for that
period. If the closing of the proposed merger does not occur by June 30, 1996,
the amounts to be paid by CAPREIT to CRIIMI will increase, to reflect additional
amounts currently being accrued for mortgage servicing and administration fees,
at a rate of $47,223 per month.

Each of the affiliates of the Partnership formed to take title to the
properties subject to the existing indebtedness (Owner Partnerships) has agreed
to either (a) sell, assign and transfer the partnership interests in, or the
real property and other assets of, such Owner Partnerships to CAPREIT or its
designee for no additional consideration or (b) admit CAPREIT or its designee as
the managing general partner, whereupon the general partner interests of the
current general partners will be converted into limited partner interests, and
CAPREIT will have the option to acquire all of the limited partner interests at
any time within five years from the closing date of the merger at the then fair
market value thereof (defined as the proportionate interest of such limited
partner in the fair market value of the partnership property as encumbered by
the mortgage loans). Although such interests currently have nominal value, if
the fair market value of the partnership properties increases prior to the time
CAPREIT exercises its option, such increase in value may benefit the owners of
the Owner Partnerships. This feature is required by CAPREIT as a condition of
the merger.

Consummation of the merger is contingent upon the approval of a majority of
BAC Holders. The proposed merger is also contingent upon receiving a favorable
opinion regarding the fairness of the redemption amount to BAC Holders from a
financial point of view. A favorable opinion from an independent investment
banking firm was issued on March 14, 1996. A proxy statement is expected to be
issued to BAC Holders after it is filed with and clearance is received from the
SEC. A preliminary proxy statement was filed with the SEC on March 18, 1996.
These definitive proxy materials include a full description of the proposed
merger and the independent fairness opinion.

3. INVESTMENTS

-6-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

3. INVESTMENTS - Continued

continued to account for its investments in mortgage revenue bonds, except
Observatory II, as investments in real estate based on ADC determination or
consolidation of the Owner Partnerships in accordance with the SEC rules.

In conjunction with the review of the Partnership's 1995 financial
statements by the SEC staff, the Partnership agreed to account for all of its
investments in mortgage revenue bonds as debt securities under the provisions of
SFAS 115 effective January 1, 1994, and restate its 1995 and 1994 financial
statements to reflect this change. Accordingly, effective January 1, 1994, all
investments in mortgage revenue bonds are classified and accounted for as held
to maturity securities and carried at amortized cost because of the
Partnership's ability and intent to hold these investments to maturity. In
accordance with SFAS 115's provisions for held to maturity securities, the
Partnership evaluates the fair value of its mortgage revenue bonds to determine
if impairment exists. If a decline in fair value is determined to be other-
than-temporary, the security is written down to its fair value. The Partnership
did not recognize any impairment losses during the three months ended March 31,
1996 or 1995. Since all of the mortgage revenue bonds are either in default or
have been previously written down due to impairment, base interest and
contingent interest on the mortgage revenue bonds is recognized as revenue when
collected.

The restatement of the 1995 financial statements resulted in increases of
$715,260 and $0.14 in the Partnership's previously reported net income and net
income per BAC, respectively, for the first quarter of 1995. Income per BAC as
previously reported for the first quarter of 1995 was $0.19.

The Partnership invested in eight Federally tax-exempt mortgage revenue
bonds with aggregate principal and carrying amounts of $97,101,000 and
$70,951,947, respectively, and made three working capital loans with aggregate
principal and carrying amounts of $3,409,604 and $0, respectively. As of March
31, 1996, six properties collateralizing certain of the mortgage revenue bonds
have been transferred by deed in lieu of foreclosure (or by transfer of
partnership interests in the borrower entity) to Owner Partnerships, subject to
existing indebtedness. In connection with the transfers of properties to Owner
Partnerships, the Partnership obtained an opinion from its former independent
accounting firm in July of 1991 that the reduction in pay rate and compounding
of unpaid base interest at the original base interest rate would not cause a
reissuance of the bonds under Section 103 of the Internal Revenue Code of 1986,
as amended (the Code) (which would cause the bonds to lose their tax-exempt
status). The Partnership also obtained opinions from certain bond counsel that
certain transfers of the properties to Owner Partnerships would not cause the
Partnership to become a substantial user of the projects or a related party to a
substantial user pursuant to Section 103 of the Code (which also could have
caused the bonds to lose their tax-exempt status). The bond counsel opinions
were obtained in connection with the Ethan's Glen IIA and Ocean Walk transfers.

-7-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

3. INVESTMENTS - Continued

provide that certain modifications of the current interest payments or maturity
date of a debt instrument will be treated as a taxable exchange of the original
instrument for the modified debt instrument. As a result of this treatment,
modifications of the mortgage loans which secure the mortgage revenue bonds
could be treated as a deemed reissuance of the mortgage revenue bonds for
federal income tax purposes. Any reissuance without the cooperation of the
mortgage revenue bond issuers would result in the loss of the tax-exempt status
of the mortgage revenue bonds. Such issuers might cooperate and consent to the
reissuance; however, there can be no assurance that such issuers would do so or
would not impose additional requirements that would have an adverse impact on
the properties.

Even if issuer consent were obtained, if the modifications are considered
material, the debt would have to be re-examined to determine whether it would
still be considered debt for tax purposes. This could result in a write-down of
principal, would most likely result in a write-off of all accrued and unpaid
past due interest and could change the contingent interest feature of the
existing mortgage loans. The write down of principal and unpaid interest would
not be recoverable upon ultimate disposition or payoff of the mortgage revenue
bond and would instead accrue to the benefit of the Owner Partnership to the
extent realized.

Proposed Regulation Section 1.001-3 will become effective only with respect
to modifications made on or after the date that is 30 days after the publication
of final regulations in the Federal Register. It is uncertain at this time when
this proposed regulation will be finalized and whether it will be finalized in
its current form. It is also unclear at this time what effect the Cottage
Savings decision may have on modifications that have been made to mortgage loans
which secure the mortgage revenue bonds or on modifications that might be
appropriate in the future. The General Partner believes that the modifications
which have been made were consistent with the relevant tax authority which
existed at the time of those modifications and have not jeopardized the tax-
exempt status of the mortgage revenue bonds. However, there can be no assurance
as to the tax-exempt status of the mortgage revenue bonds.

In March 1994, the Partnership was notified by the management agent of
Woodlane Place that certain buildings at the property experienced damage due to
frost heaving. The Owner Partnerships hired an engineer to analyze the
underlying problem of inadequate drainage at the property and to determine the
number of affected buildings and the severity of the drainage problem. Based on
this analysis, the costs associated with the correction of the drainage problem
are expected to be approximately $300,000, and will not be covered by the
property's insurance carrier. Due to the nature of the drainage problem,
occupancy levels at the property are not expected to decrease as a result of the
ongoing capital improvements. Funding for these capital improvements may be
provided from the borrowers existing replacement reserves, future property cash
flow, and/or a loan to the borrower from the working capital reserves of the
Partnership. The Partnership has joined with the borrower's insurance carrier
in a lawsuit against the original architect and general contractor of Woodlane
Place. The Partnership has joined on a contingent basis, with no legal fees
being incurred unless the Partnership receives a settlement or judgment, and
with other legal expenses estimated to be less than $20,000. There is no
assurance that the Partnership will receive any funds as a result of this
lawsuit.

-8-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

3. INVESTMENTS - Continued

The General Partner's ongoing strategy has been to continue holding the
mortgage revenue bonds until the loan maturity dates. If the merger proposal,
as discussed in Note 2, is approved, the interests of the BAC Holders will be
redeemed for cash. If the merger proposal is not approved, in order to maximize
the overall yield, the General Partner may recommend, subject to satisfactory
resolution of any issues relating to the tax-exempt status of the mortgage
revenue bonds, for investor approval extension of certain loan maturity dates
and, if approved, arrange any necessary related amendments to the pertinent
mortgage revenue bonds.

Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to the Partnership from the
borrowers:

-9-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

3. INVESTMENTS - Continued

For the three months ended March 31, 1996
--------------------------------------------------------------------------------
Base Interest Base Interest Cumulative
Paid From Paid From Current Base Unpaid
Current Base Properties' Non-Operating Interest Base
Interest Due(1) Operations(3) Sources(2) Not Paid Interest
--------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Ethan's Glen IIA $ 230,234 $ 288,581 $ -- $ -- $ 262,915
Geary Courtyard 435,150 175,000 -- 260,150 5,982,653
Ocean Walk 443,607 363,106 -- 80,501 1,546,917
Paces River 2 192,256 218,733 -- -- 170,882
Regency Woods 173,365 129,800 -- 43,565 313,615
Valley Creek II 229,775 200,090 -- 29,685 737,028
Washington Ridge 218,750 218,750 -- -- 72,917
Woodlane Place 351,750 335,754 -- 15,996 2,678,404
---------- ---------- ---------- ---------- -----------
$2,274,887 $1,929,814 $ -- $ 429,897 $11,765,331
========== ========== ========== ========== ===========
</TABLE>

<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------------------------
Base Interest Base Interest Cumulative
Paid From Paid From Current Base Unpaid
Current Base Properties' Non-Operating Interest Base
Interest Due(1) Operations Sources(2) Not Paid Interest
--------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Ethan's Glen IIA $ 230,234 $ 192,548 $ -- $ 37,686 $ 192,911
Geary Courtyard 435,150 155,000 -- 280,150 5,024,053
Ocean Walk 443,607 439,435 -- 4,172 1,345,001
Paces River 2 192,256 232,460 -- -- 183,652
Regency Woods 173,365 77,313 17,834 78,218 136,006
Valley Creek II 229,775 180,660 -- 49,115 559,721
Washington Ridge 218,750 218,750 -- -- 72,917
Woodlane Place 351,750 180,897 -- 170,853 2,380,739
---------- ---------- ---------- ---------- -----------
$2,274,887 $1,677,063 $ 17,834 $ 620,194 $ 9,895,000
========== ========== ========== ========== ===========
</TABLE>

-10-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

3. INVESTMENTS - Continued

(3) Includes amounts received by the Partnership in January 1996 from the
release of excess tax and insurance reserves relating to 1995. Such
amounts received from Ethan's Glen IIA, Paces River 2 and Woodlane Place
totalled $70,000, $12,000 and $23,000, respectively.
(4) Excludes contingent interest of $27,931 received by the Partnership from
Washington Ridge during the three months ended March 31, 1995.

Contingent interest is payable quarterly on an estimated basis, in arrears
but only to the extent of available net cash flow, if any. Contingent interest
is recognized as revenue when collected. Contingent interest due as of March
31, 1996 and December 31, 1995 amounted to $39,351,070 and $37,635,033,
respectively. The Partnership received contingent interest of $0 and $27,931
from Washington Ridge during the three months ended March 31, 1996 and 1995,
respectively.

As of March 31, 1996, the Partnership had cash and cash equivalents of
$73,762, unrestricted marketable securities of $1,505,994, working capital
reserves invested in marketable securities of $4,214,873 and interest reserves
invested in marketable securities of $298,750. Marketable securities consist of
tax-exempt municipal bonds which generally contain a seven-day put option with
established banks or brokerage houses. The Partnership has classified its
investments in marketable securities into the Available for Sale category under
SFAS 115. Realized gains and losses on the sale of marketable securities were
determined on a specific identification basis. There were no net unrealized
holding gains or losses recognized during the three months ended March 31, 1996
or 1995 as the cost for the tax-exempt municipal bonds approximated fair value
throughout the respective periods.

-11-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

4. DISTRIBUTIONS TO BAC HOLDERS

The Partnership expects to continue to make distributions to BAC Holders on
a quarterly basis. The amended merger agreement stipulates that 1996
distributions cannot exceed ten cents per BAC per month. There are no other
legal restrictions on the Partnership's present or future ability to make cash
distributions other than as set forth in the amended merger agreement. The
distributions to BAC Holders have been funded from three primary sources: cash
flow from the underlying properties' operations, surplus working capital
reserves of the Partnership, and funds from property reserves/borrower
guarantees. However, because the surplus working capital reserves are almost
depleted and property reserves/borrower guarantees were depleted during the
first quarter of 1995, it is expected that distributions will be based primarily
on cash flow from the Partnership's operations. Cash flow from the
Partnership's operations consists of cash flow from six of the properties, plus
specified interest payments from two properties and contingent interest from one
property, supplemented by any available property reserves/borrower guarantees,
less Partnership expenses. The General Partner seeks to optimize cash flow from
the properties owned by Owner Partnerships. Despite these efforts, the amounts
paid to the Partnership from the borrowers may be expected to fluctuate from
period to period due to changes in occupancy rates, rental rates, operating
expenses and other variables.

The following distributions were paid or accrued to BAC Holders of record
for the first quarter of 1996 and 1995:

<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
------------------------- ---------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- ----------- ------- ----------- -------
<S> <C> <C> <C> <C>
March 31, $ 1,577,480 $ 0.30 $ 1,577,480 $ 0.30
=========== ======= =========== =======
</TABLE>

Distributions to BAC Holders for the three months ended March 31, 1996 and
1995 were funded as follows:

-12-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

4. DISTRIBUTIONS TO BAC HOLDERS - Continued

<TABLE>
<CAPTION>
For the three months ended
March 31,
--------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash flow (1) $ 1,573,304 $ 1,595,292
Withdrawals from (deposits to) working
capital/interest reserves 20,271 (1,717)
------------ ------------
Total cash available for distribution $ 1,593,575 $ 1,593,575
============ ============
Distributions to:
General Partner (1.01%) $ 16,095 $ 16,095
============ ============
BAC Holders (98.99%) $ 1,577,480 $ 1,577,480
============ ============
</TABLE>

(1) Defined in the Limited Partnership Agreement as (a) all revenues received
by the Partnership during such period, plus (b) any amounts which the
Managing General Partner releases from the Working Capital Reserve as being
no longer necessary to hold as part of the Working Capital Reserve, plus
(c) any amounts released to the Partnership from the Interest Reserve
Account with respect to a mortgaged property after completion of
construction of such mortgaged property, less (i) operating expenses of the
Partnership paid from reserves during the period, including any expenses
paid to the General Partner, but not including such amounts paid from the
Working Capital Reserve, (ii) all cash payments made from Revenues during
such period to discharge Partnership indebtedness, and (iii) all amounts
from revenues, if any, added to the Working Capital Reserve during such
period. Cash flow as defined in the Limited Partnership Agreement is not
to be construed as an alternative to operating income in accordance with
GAAP as an indication of the Partnership's operating performance.

The Partnership's working capital reserves may be available for the ongoing
costs of operating the Partnership, for supplementing distributions to investors
and for making working capital loans to the borrowers. As of March 31, 1996 and
December 31, 1995, the working capital reserves were $4,214,873 and $4,235,144,
respectively, both of which exceed the Partnership's minimum working capital
reserve balance of approximately $3,718,000. The minimum working capital
reserve balance may be increased or decreased from time to time as deemed
necessary by the General Partner. The surplus working capital reserve balance
of approximately $497,000 as of March 31, 1996 may be used to supplement
distributions to BAC Holders. Of the total distributions made during the three
months ended March 31, 1996 and 1995, $20,271 and $0, respectively, were funded
from the surplus working capital reserves.

Interest reserves relating to Washington Ridge were $298,750 as of March
31, 1996 and December 31, 1995. During the three months ended March 31, 1996
and 1995, amounts of $0 and $96,090, respectively, were transferred to working
capital reserves to fund distributions to BAC Holders from the interest

-13-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

4. DISTRIBUTIONS TO BAC HOLDERS - Continued

reserves.

5. INCOME TAXES

For income tax purposes, base interest income is accrued when earned. The
accrual of base interest is discontinued when at the time of accrual, ultimate
collectibility of the base interest due is considered unlikely. Once a loan has
been placed on a non-accrual status, income is recorded only as cash payments
are received from the borrower or nominee until such time as the uncertainty of
collection of unpaid base interest is eliminated. Loans relating to Geary
Courtyard, Valley Creek II and Woodlane Place were placed on a non-accrual
status in 1993; therefore, for income tax purposes, income is recognized to the
extent of cash received. Contingent interest from the investment is recognized
as revenue when collected. Contingent interest of $0 and $27,931 was recognized
from Washington Ridge for the three months ended March 31, 1996 and 1995,
respectively.

For federal income tax purposes, the investments in all of these mortgage
revenue bonds are treated as loans, interest on which is exempt from federal
income tax. A reconciliation of the primary differences between the financial
statement net income and municipal income for tax purposes is as follows:

<TABLE>
<CAPTION>
For the three months ended
March 31,
-------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Financial statement net income $ 1,734,038 $ 1,656,548
Adjustment for timing of municipal
income recognition 268,193 67,351
------------ ------------
Municipal income, net for tax purposes $ 2,002,231 $ 1,723,899
============ ============
Municipal income per BAC $ 0.38 $ 0.32
============ ============

</TABLE>

6. LITIGATION

On September 22, 1995, Irving Zakin commenced a putative class action (the
Zakin Action) against the Partnership, its General Partner (CRITEF III
Associates Limited Partnership), its Assignor Limited Partner (CRITEF III,
Inc.), CRI, William B. Dockser, H. William Willoughby, Capital Realty Investors
Tax Exempt Fund Limited Partnership, CRITEF Associates Limited Partnership,
CRITEF, Inc., and CAPREIT (collectively, the Defendants) in the Court of
Chancery of the State of Delaware in New Castle County (the Chancery Court)
(C.A. No. 14558). The complaint alleges, among other things, that the amount
offered to the BAC Holders in the proposed merger at the time the complaint was
filed was inadequate, and that the Defendants breached their fiduciary duty to
the BAC Holders, or aided and abetted such a breach, engaged in self-dealing and

-14-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

6. LITIGATION - Continued

misled BAC Holders in connection with the proposed merger. The suit seeks to
enjoin the proposed merger, to obtain damages in an unspecified amount for the
BAC Holders, and to compel the Defendants to maximize the amount paid to the BAC
Holders and consider unspecified alternatives to the proposed merger.

On October 5, 1995, David and Johanna Wingard (the Wingard Action)
commenced a second putative class action against the Defendants in the Chancery
Court (C.A. No 14604). The complaint in the Wingard Action contains virtually
the identical allegations and seeks virtually the identical relief as in the
Zakin Action. A request to the Chancery Court has been made by the plaintiffs
in both lawsuits to consolidate the two actions.

On January 31, 1996, the Defendants and the plaintiffs and their respective
attorneys reached a tentative settlement of the putative class actions which is
memorialized in a Memorandum of Understanding (the Memorandum), dated as of such
date. The proposed settlement must be approved by the Chancery Court. The
Memorandum contemplates the complete discharge, settlement and release of all
claims that have been, could have been, or in the future might be asserted in
any action or any other proceeding in connection with the proposed merger. The
parties to the Memorandum will use their best efforts to execute an appropriate
Stipulation of Settlement (the Stipulation) and such other documents as may be
required in order to obtain approval by the Chancery Court of the settlement.

The Defendants have denied, and continue to deny, that any of them have
committed or threatened to commit any violations of law or breaches of duty to
the BAC Holders. The Defendants have entered into the Memorandum solely because
the proposed settlement would eliminate the burden and expense of further
litigation and would facilitate the consummation of the proposed merger, which
the General Partner believes to be in the best interest of the BAC Holders.

In accordance with the Memorandum, the agreements for the proposed merger
were amended to provide for the revised merger terms, as discussed above.
Pursuant to the Memorandum, the plaintiffs' counsel will be entitled to apply to
the Chancery Court for an award of reasonable attorneys' fees and expenses.
Such expenses are not expected to exceed $0.19 per BAC. These fees will reduce
the redemption amounts to BAC Holders in connection with the proposed merger, as
discussed. In the event that the proposed merger is not consummated, these fees
will not be borne by the Partnership. As such, the Partnership's financial
statements do not include any adjustment for these fees.

Counsel for the plaintiffs have reviewed certain documents relating to the
proposed mergers, and will have the opportunity to review and take depositions
of representatives of the General Partner and CAPREIT. After such review,
counsel for the plaintiffs shall have the right to terminate the settlement
contemplated in the Memorandum, based on material information not presently
available to them.

After the Stipulation is executed, the parties will seek preliminary
approval of the settlement by the Chancery Court and will then mail notice of
the proposed settlement to members of the putative class. As soon as
practicable following completion of the discovery described in the preceding
paragraph and after class members have had a period of time to review the notice
of proposed settlement, the parties will use their best efforts to obtain final
Chancery Court approval of the settlement and the dismissal of the class actions
as to all of the claims.

-15-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

6. LITIGATION - Continued

On November 9, 1995, CRI filed a complaint against Capital Management
Strategies, Inc. (CMS), a company controlled by Martin C. Schwartzberg, to
determine the proper amount of fees to be paid in 1996 under an asset management
agreement. CMS answered on January 10, 1996, but asserted no counterclaims.

Thereafter, Mr. Schwartzberg launched a hostile consent solicitation to be
designated as managing general partner of approximately 125 private partnerships
sponsored by CRI. Mr. Schwartzberg is a former shareholder and executive
officer of CRI who decided to leave the company as of January 1, 1990. In
connection with his departure, he relinquished his general partner duties for
all CRI-sponsored partnerships, including those of the General Partner. On
March 28, 1996, Mr. Schwartzberg filed a preliminary proxy statement with the
SEC opposing the proposed merger.

On January 18, 1996, Mr. Schwartzberg and CMS filed a complaint in the
Circuit Court of Montgomery County, Maryland (the Circuit Court), against CRI
and Messrs. Dockser and Willoughby alleging, among other things, (i) that CRI
and Messrs. Dockser and Willoughby have breached an asset management agreement
pursuant to which Mr. Schwartzberg's company, CMS, agreed to perform limited
functions related to property-level issues for a portion of CRI's subsidized
housing portfolio (but not properties securing the mortgage revenue bonds) by
reducing the proposed budget for 1996, (ii) that the actions of CRI and Messrs.
Dockser and Willoughby in connection with the proposed merger involve self-
dealing and constitute a breach of their fiduciary duties to Mr. Schwartzberg,
and (iii) that the actions in connection with the merger of CRIIMI MAE Inc. in
June, 1995 involved self-interest and led in part to the proposed reduction of
the asset management agreement budget. Neither the Partnership nor the General
Partner was named as a defendant in this action, and Mr. Schwartzberg does not
allege that he is a BAC Holder. Messrs. Dockser and Willoughby have entered an
answer denying all of Mr. Schwartzberg's claims and moving to strike the
allegations concerning the Partnership and CRIIMI MAE Inc. and dismiss the
related counts for failure to state a claim upon which relief can be granted.
Messrs. Dockser and Willoughby have publicly responded that Mr. Schwartzberg's
suit is motivated by his budget dispute with CRI and personal animosity.

On February 12, 1996, the Circuit Court issued a memorandum opinion and
order enjoining CMS and Mr. Schwartzberg from disclosing information made
confidential under the asset management agreement.

On February 15, 1996, Mr. Schwartzberg filed suit in the Chancery Court
against the General Partner and CRITEF Associates Limited Partnership (No.
14837). He alleges that he has made demands upon the General Partner and CRITEF
III Associates Limited Partnership, in his capacity as a general and limited
partner of the General Partner and as a limited partner of CRITEF III Associates
Limited Partnership, to inspect and obtain copies of a current list of the BAC
holders and other documents. He further alleges that his demands were rejected.
On February 23, 1996, the General Partner and CRITEF III Associates Limited
Partnership answered the complaint, admitting that his demands have been
rejected and denying that Mr. Schwartzberg is entitled to the materials
requested because, among other things, he lacks standing and proper purpose to
inspect and obtain copies of the requested materials. A hearing was held on
March 6 and 7, 1996 and it is expected that the Chancery Court will render a
decision following submission of briefs by the parties.

On February 16, 1996, the Partnership, together with the General Partner,

-16-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

6. LITIGATION - Continued

Capital Realty Investors Tax Exempt Fund Limited Partnership and its general
partner, CRI and CAPREIT (collectively, the Plaintiffs) filed suit against Mr.
Schwartzberg in the United States District Court for the Southern District of
New York (the District Court), No. 96 Civ. 1186 (LAK) (the New York Action).
The complaint alleges that Mr. Schwartzberg is engaged in an unlawful
solicitation of proxies of the BAC Holders through two press releases he issued
in violation of the federal securities laws and rules promulgated by the SEC
requiring definitive proxy materials to be filed with the SEC and delivered to
the BAC Holders. The complaint also alleges that Mr. Schwartzberg has made
false and misleading statements in the solicitations concerning the terms of the
proposed merger and the availability of certain financial information, and has
falsely imputed base motives to the principals of the General Partner. On
February 23, 1996, the District Court, without making a finding of fact, issued
a temporary restraining order barring Mr. Schwartzberg from making any
solicitation of the BAC Holders without first complying with the SEC rules
pending a hearing on a proposed preliminary injunction. The District Court held
a hearing on March 5, 1996, on the motion of preliminary injunction, and,
pending a decision, continued the temporary restraining order.

On March 18, 1996, the District Court issued its Opinion enjoining Mr.
Schwartzberg from (1) making any further solicitation of BAC Holders without
complying with the provisions of Regulation 14A under the Securities Exchange
Act of 1934, and (2) committing any violation of Rule 14a-9 (regarding false or
misleading statements) in connection with any solicitation relating to the
Partnerships. The injunction was based on the District Court's findings of fact
and conclusions of law, in which it stated that the Plaintiffs (including the
Partnership) have established a strong likelihood of success on their claim that
the press releases constitute a proxy solicitation in violation of securities
laws and that the Plaintiffs are likely to establish that Mr. Schwartzberg acted
with the requisite culpability with respect to at least some of the false
statements made in his press releases. Also on March 18, 1996, Mr. Schwartzberg
filed his answer to the complaint in the New York action, coupled with
counterclaims against the General Partner alleging that three press releases
issued by the General Partner of the Partnership constituted solicitations in
violation of the same provisions of the Securities Exchange Act and that they
were false and misleading. The counter-defendants deny the allegations. The
counter claims sought a temporary restraining order against the General Partner
regarding further alleged solicitations and false and misleading statements.
The District Court denied the injunction request by order on April 23, 1996. On
April 16, 1996, Mr. Schwartzberg also filed a Notice of Appeal with respect to
the injunction against him with the U. S. Court of Appeals for the Second
Circuit.

The Partnership Agreement provides for the indemnification of the General
Partners and its affiliates for acts or omissions by the General Partner in good
faith and in the best interest of the Partnership. Such indemnification does
not extend to a finding of liability for conduct which constitutes fraud, bad
faith, misconduct, breach of fiduciary duties or violation of state or federal
securities laws. At this time, there is no estimate as to the timing or amount,
if any, of the outcome of the New York Action, but the General

-17-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

6. LITIGATION - Continued

Partners do not anticipate that the litigation will have a material adverse
affect on the Partnership.

7. RELATED-PARTY TRANSACTIONS

The General Partner has the authority and responsibility for, among other
things, the overall management and control of the Partnership. The General
Partner and its affiliates do not receive any fees from the Partnership for
their services to the Partnership, but are reimbursed by the Partnership for any
actual costs and expenses incurred in connection with the operation of the
Partnership. During the three months ended March 31, 1996 and 1995, $37,954 and
$53,559, respectively, were reimbursed for such costs and are included in
general and administrative expense and merger-related expense in the statements
of income.

CRICO Mortgage Company, Inc. (CRICO Mortgage), a former affiliate of the
General Partner, was entitled to annual mortgage administration and servicing
fees from the borrowers which were payable from operating revenues each month
after payment of full base interest on the mortgage loans. On June 30, 1995,
CRICO Mortgage merged with and into CRIIMI, an affiliate of CRIIMI MAE Inc., a
publicly traded real estate investment trust (the REIT). The REIT was
originally sponsored by CRI, the general partner of the General Partner, but is
not controlled by CRI, although the CRI stockholders are directors, officers and
major stockholders of the REIT. Pursuant to the REIT merger agreement, the
right to receive the accrued and unpaid mortgage administration and servicing
fees as of the date of the REIT merger was distributed by CRICO Mortgage to its
shareholders and contributed by them to CRI. After June 30, 1995, the mortgage
administration and servicing are being performed by CRIIMI and mortgage
administration and servicing fees are payable to that entity. The merger did
not result in any increase in fees or changes in the amount of fees which are
currently payable.

The following unpaid fees were due to CRI and CRIIMI from the borrowers as
of March 31, 1996 and December 31, 1995:

<TABLE>
<CAPTION>
As of As of
March 31, December 31,
1996 1995
----------- -----------
<S> <C> <C>
CRI $ 1,578,694 $ 1,578,694
CRIIMI 425,006 283,338
----------- -----------
Total $ 2,003,700 $ 1,862,032
=========== ===========
</TABLE>

The unpaid fees are payable from available cash flow after payment of all
current and delinquent base interest and accrued interest on delinquent base
interest. If available cash flow from the borrower is insufficient to pay the
fee, it is payable on the earlier of prepayment or maturity of the loan, after
debt repayment. Any payments made with respect to unpaid fees will be applied
against the oldest outstanding fees first.

-18-
<PAGE>
CAPITAL REALTY INVESTORS TAX EXEMPT FUND III LIMITED PARTNERSHIP

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

7. RELATED-PARTY TRANSACTIONS - Continued

In connection with the amended merger agreement entered into by the
Partnership, as discussed in Note 2, unpaid fees accrued through June 30, 1995
will be purchased from CRI for the discounted amount of $667,485, which
represents approximately 42% of the total accrued fees owed to CRI. In
addition, unpaid fees accrued from July 1, 1995 through June 30, 1996 will be
purchased by CAPREIT from CRIIMI for $556,674, which represents 100% of the
accrued fees which are expected to be owed to CRIIMI for that period. The
proposed purchase price for CRIIMI's portion remains in effect until June 30,
1996. If the proposed merger is not consummated by such date, the purchase
price of CRIIMI's portion will be adjusted upward at a rate of $47,223 per
month.

Fees paid by the borrowers to CRI/CRICO Mortgage and CRIIMI for the three
months ended March 31, 1996 and 1995 were as follows:

<TABLE>
<CAPTION>
For the three months ended
March 31,
1996 1995
----------- -----------
<S> <C> <C>
CRI/CRICO Mortgage $ -- $ 22,687
CRIIMI 18,750 -
----------- -----------
Total $ 18,750 $ 22,687
=========== ===========
</TABLE>

Owner Partnerships formed to take title to properties, subject to existing
indebtedness, are structured as limited partnerships. The Owner Partnerships
and the managing general partner of the General Partner have primarily common
ownership (except for Ethan's Glen IIA prior to March 14, 1996) and are under
common control. The Owner Partnerships, rather than the Partnership, became
holders of title to the properties in an effort to maintain the tax exempt
nature of the interest on the mortgage revenue bonds. No compensation or fees
were paid by the Partnership to the Owner Partnerships or their principal in
connection with the transfers of ownership.

In connection with the amended merger agreement, each of the Owner
Partnerships has agreed to either (a) sell, assign and transfer the partnership
interests in, or the real property and other assets of, such Owner Partnerships
to CAPREIT or its designee for no additional consideration or (b) admit CAPREIT
or its designee as the managing general partner, whereupon the general partner
interests of the current general partners will be converted into limited partner
interests, and CAPREIT will have the option to acquire all of the limited
partner interests at any time within five years from the closing date of the
merger at the then fair market value (defined as the proportionate interest of
such limited partner in the fair market value of the partnership property as
encumbered by the mortgage loans) thereof. Although such interests currently
have nominal value, if the fair market value of the partnership properties
increases prior to the time CAPREIT exercises its option, such increase in value
may benefit the owners of the Owner Partnerships.

-19-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------

Business
--------

The Partnership's 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/A,
that could cause actual results to differ materially.

In May 1993, the Financial Accounting Standards Board (FASB) issued
Statement on Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). This statement requires
that most investments in securities be classified into one of the following
investment categories based upon circumstances under which securities might be
sold: Held to Maturity, Available for Sale, and Trading. Generally,
investments in securities for which an enterprise has both the ability and the
intent to hold to maturity should be accounted for using the amortized cost
method and all other securities must be recorded at their fair values. The
Partnership implemented SFAS 115 in 1994 for its marketable securities.
Following such adoption, the Partnership (as did others in the industry)
continued to account for its investments in mortgage revenue bonds, except
Observatory II, as investments in real estate based on ADC determination or
consolidation of the affiliates of the Partnership formed to take title to the
properties subject to existing indebtedness (Owner Partnerships) in accordance
with the Securities and Exchange Commission (SEC) rules.

-20-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

as amended (the Code) (which would cause the bonds to lose their tax-exempt
status). The Partnership also obtained opinions from certain bond counsel that
certain transfers of the properties to Owner Partnerships would not cause the
Partnership to become a substantial user of the projects or a related party to a
substantial user pursuant to Section 103 of the Code (which also could have
caused the bonds to lose their tax-exempt status). The bond counsel opinions
were obtained in connection with the Ethan's Glen IIA and Ocean Walk transfers.

In April 1991, the U.S. Supreme Court decided a case, Cottage Savings
Association V. Commissioner (Cottage Savings) that could be interpreted to
impact then existing authority addressing the modification of debt instruments.
In response to this decision in December 1992 the Internal Revenue Service
issued Proposed Regulation Section 1.1001-3 which specifically address the tax
consequences of modifications of debt instruments. Among other things, these
proposed regulations, if they become effective in their current form, would
provide that certain modifications of the current interest payments or maturity
date of a debt instrument will be treated as a taxable exchange of the original
instrument for the modified debt instrument. As a result of this treatment,
modifications of the mortgage loans which secure the mortgage revenue bonds
could be treated as a deemed reissuance of the mortgage revenue bonds for
federal income tax purposes. Any reissuance without the cooperation of the
mortgage revenue bond issuers would result in the loss of the tax-exempt status
of the mortgage revenue bonds. Such issuers might cooperate and consent to the
reissuance; however, there can be no assurance that such issuers would do so or
would not impose additional requirements that would have an adverse impact on
the properties.

-21-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

this analysis, the costs associated with the correction of the drainage problem
are expected to be approximately $300,000, and will not be covered by the
property's insurance carrier. Due to the nature of the drainage problem,
occupancy levels at the property are not expected to decrease as a result of the
ongoing capital improvements. Funding for these capital improvements may be
provided from the borrowers existing replacement reserves, future property cash
flow, and/or a loan to the borrower from the working capital reserves of the
Partnership. The Partnership has joined with the borrower's insurance carrier
in a lawsuit against the original architect and general contractor of Woodlane
Place. The Partnership has joined on a contingent basis, with no legal fees
being incurred unless the Partnership receives a settlement or judgment, and
with other legal expenses estimated to be less than $20,000. There is no
assurance that the Partnership will receive any funds as a result of this
lawsuit.

Merger Proposal
- ---------------

-22-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

1.01% general partner interest in the Partnership.

Each of the Owner Partnerships has agreed to either (a) sell, assign and
transfer the partnership interests in, or the real property and other assets of,
such Owner Partnerships to CAPREIT or its designee for no additional
consideration or (b) admit CAPREIT or its designee as the managing general
partner, whereupon the general partner interests of the current general partners
will be converted into limited partner interests, and CAPREIT will have the
option to acquire all of the limited partner interests at any time within five
years from the closing date of the merger at the then fair market value thereof
(defined as the proportionate interest of such limited partner in the fair
market value of the partnership property as encumbered by the mortgage loans).
Although such interests currently have nominal value, if the fair market value
of the partnership properties increases prior to the time CAPREIT exercises its
option, such increase in value may benefit the owners of the Owner Partnerships.
This feature is required by CAPREIT as a condition of the merger.

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

The primary sources of the Partnership's future cash flows are expected to
be from receipts of base interest on mortgage loans, which are dependent upon
the net operating income of the properties. Therefore, the Partnership's
investment in the mortgage revenue bonds and working capital loans is subject to
the general risks inherent to the ownership of real property. These risks
include reduction in rental income due to an inability to maintain occupancy
levels, adverse changes in general economic conditions, and adverse changes in
local conditions. The General Partner expects that the properties transferred
to Owner Partnerships, subject to existing indebtedness, will continue to
generate sufficient cash flow to pay all operating expenses, meet escrow deposit

-23-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

requirements and pay some, but not all, of the base interest due to the
Partnership. The Partnership has no material commitments for capital expendi-
tures.

The following distributions were paid or accrued to BAC Holders of record
for the first quarter of 1996 and 1995:

-24-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

<TABLE>
<CAPTION>
1996 1995
Distributions to Distributions to
BAC Holders BAC Holders
---------------------------- ---------------------------
Quarter Ended Total Per BAC Total Per BAC
- ------------- ----------- ------- ----------- -------
<S> <C> <C> <C> <C>
March 31, $ 1,577,480 $ 0.30 $ 1,577,480 $ 0.30
=========== ======= =========== =======
</TABLE>

Distributions to BAC Holders for the three months ended March 31, 1996 and
1995 were funded as follows:

<TABLE>
<CAPTION>
For the three months ended
March 31,
-----------------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash flow (1) $ 1,573,304 $ 1,595,292
Withdrawals from (deposits to) working
capital/interest reserves 20,271 (1,717)
------------ ------------
Total cash available for distribution $ 1,593,575 $ 1,593,575
============ ============
Distributions to:
General Partner (1.01%) $ 16,095 $ 16,095
============ ============
BAC Holders (98.99%) $ 1,577,480 $ 1,577,480
============ ============
</TABLE>

The General Partner expects the distribution for the quarter ending June

-25-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

30, 1996 to be approximately $0.30 per BAC, payable on August 14, 1996, or
possibly earlier depending on the merger closing date, to BAC Holders of record
as of the last day in each month.

As of March 31, 1996, the Partnership had cash and cash equivalents of
$73,762 and unrestricted marketable securities of $1,505,994. Marketable
securities consist of tax-exempt municipal bonds which generally contain a
seven-day put option with established banks or brokerage houses. The
Partnership has classified its investments in marketable securities into the
Available for Sale category under SFAS 115. Realized gains and losses on the
sale of marketable securities were determined on a specific identification
basis. There were no net unrealized holding gains or losses recognized during
the three months ended March 31, 1996 or 1995 as the cost for the tax-exempt
municipal bonds approximated fair value throughout the respective periods.

The Partnership closely monitors its cash flow and liquidity position in an
effort to ensure that sufficient cash is available for operating requirements
and distributions to BAC Holders. The Partnership's net cash provided by
operating activities, which consists primarily of receipt of base interest on
mortgage loans, for the three months ended March 31, 1996 was adequate to
support operating, investing and financing requirements and the declared
distributions to BAC Holders and the General Partner. The Partnership estimates
that future cash flows from receipt of base interest on mortgage loans, in the
aggregate, will be sufficient to pay operating expenses and make distributions
to BAC Holders and the General Partner.

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

The Partnership's net income for the three months ended March 31, 1996
increased approximately $77,500 or 5% from the corresponding period in 1995
primarily due to an increase in interest from mortgage revenue bonds of
approximately $207,000 resulting principally from the release of $105,000 in
excess tax and insurance reserves relating to three of the underlying properties
during the first quarter of 1996, as well as an increase in rental rates and
occupancy at all of the underlying properties. Partially offsetting the

-26-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

increase in net income were merger-related expenses incurred in the first
quarter of 1996 of approximately $152,000. There were no material increases or
decreases in the Partnership's remaining income or expenses.

Presented below is a summary of base interest payments for the three months
ended March 31, 1996 and 1995 that are due to the Partnership from the
borrowers:

-27-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

For the three months ended March 31, 1996
----------------------------------------------------------------------------------
Base Interest Base Interest Cumulative
Paid From Paid From Current Base Unpaid
Current Base Properties' Non-Operating Interest Base
Interest Due(1) Operations(3) Sources(2) Not Paid Interest
--------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Ethan's Glen IIA $ 230,234 $ 288,581 $ -- $ -- $ 262,915
Geary Courtyard 435,150 175,000 -- 260,150 5,982,653
Ocean Walk 443,607 363,106 -- 80,501 1,546,917
Paces River 2 192,256 218,733 -- -- 170,882
Regency Woods 173,365 129,800 -- 43,565 313,615
Valley Creek II 229,775 200,090 -- 29,685 737,028
Washington Ridge 218,750 218,750 -- -- 72,917
Woodlane Place 351,750 335,754 -- 15,996 2,678,404
---------- ---------- ---------- ---------- -----------
$2,274,887 $1,929,814 $ -- $ 429,897 $11,765,331
========== ========== ========== ========== ===========
</TABLE>

<TABLE>
<CAPTION>
For the three months ended March 31, 1995
---------------------------------------------------------------------------------
Base Interest Base Interest Cumulative
Paid From Paid From Current Base Unpaid
Current Base Properties' Non-Operating Interest Base
Interest Due(1) Operations Sources(2) Not Paid Interest
--------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C><C>
Ethan's Glen IIA $ 230,234 $ 192,548 $ -- $ 37,686 $ 192,911
Geary Courtyard 435,150 155,000 -- 280,150 5,024,053
Ocean Walk 443,607 439,435 -- 4,172 1,345,001
Paces River 2 192,256 232,460 -- -- 183,652
Regency Woods 173,365 77,313 17,834 78,218 136,006
Valley Creek II 229,775 180,660 -- 49,115 559,721
Washington Ridge 218,750 218,750 -- -- 72,917
Woodlane Place 351,750 180,897 -- 170,853 2,380,739
---------- ---------- ---------- ---------- -----------
$2,274,887 $1,677,063 $ 17,834 $ 620,194 $ 9,895,000
========== ========== ========== ========== ===========
</TABLE>

(1) The Partnership charges the borrowers interest on unpaid base interest
which totalled $300,848 and $237,589 for the three months ended March 31,
1996 and 1995, respectively.
(2) Amounts were funded from reserves provided for from the mortgage loan
proceeds and/or funds from the general partners of the borrowers.
(3) Includes amounts received by the Partnership in January 1996 from the
release of excess tax and insurance reserves relating to 1995. Such
amounts received from Ethan's Glen IIA, Paces River 2 and Woodlane Place

-28-
<PAGE>
PART I. FINANCIAL INFORMATION
---------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS - Continued
-----------------------------------

totalled $70,000, $12,000 and $23,000, respectively.
(4) Excludes contingent interest of $27,931 received by the Partnership from
Washington Ridge during the three months ended March 31, 1995.

Contingent interest is payable quarterly on an estimated basis, in arrears
but only to the extent of available net cash flow, if any, and is recognized as
revenue when collected. Contingent interest due as of March 31, 1996 and
December 31, 1995 amounted to $39,351,070 and $37,635,033, respectively. The
Partnership received contingent interest of $0 and $27,931 from Washington Ridge
during the three months ended March 31, 1996 and 1995, respectively.

PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS
-----------------

-29-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------

litigation and would facilitate the consummation of the proposed merger, which
the General Partner believes to be in the best interest of the BAC Holders.

-30-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------

answer denying all of Mr. Schwartzberg's claims and moving to strike the
allegations concerning the Partnership and CRIIMI MAE Inc. and dismiss the
related counts for failure to state a claim upon which relief can be granted.
Messrs. Dockser and Willoughby have publicly responded that Mr. Schwartzberg's
suit is motivated by his budget dispute with CRI and personal animosity.

On February 12, 1996, the Circuit Court issued a memorandum opinion and
order enjoining CMS and Mr. Schwartzberg from disclosing information made
confidential under the asset management agreement.

On February 16, 1996, the Partnership, together with the General Partner,
Capital Realty Investors Tax Exempt Fund Limited Partnership and its general
partner, CRI and CAPREIT (collectively, the Plaintiffs) filed suit against Mr.
Schwartzberg in the United States District Court for the Southern District of
New York (the District Court), No. 96 Civ. 1186 (LAK) (the New York Action).
The complaint alleges that Mr. Schwartzberg is engaged in an unlawful
solicitation of proxies of the BAC Holders through two press releases he issued
in violation of the federal securities laws and rules promulgated by the SEC
requiring definitive proxy materials to be filed with the SEC and delivered to
the BAC Holders. The complaint also alleges that Mr. Schwartzberg has made
false and misleading statements in the solicitations concerning the terms of the
proposed merger and the availability of certain financial information, and has
falsely imputed base motives to the principals of the General Partner. On
February 23, 1996, the District Court, without making a finding of fact, issued
a temporary restraining order barring Mr. Schwartzberg from making any
solicitation of the BAC Holders without first complying with the SEC rules
pending a hearing on a proposed preliminary injunction. The District Court held
a hearing on March 5, 1996, on the motion of preliminary injunction, and,
pending a decision, continued the temporary restraining order.

-31-
<PAGE>
PART II. OTHER INFORMATION
-----------------
ITEM 1. LEGAL PROCEEDINGS - Continued
-----------------

counterclaims against the General Partner alleging that three press releases
issued by the General Partner of the Partnership constituted solicitations in
violation of the same provisions of the Securities Exchange Act and that they
were false and misleading. The counter-defendants deny the allegations. The
counter claims sought a temporary restraining order against the General Partner
regarding further alleged solicitations and false and misleading statements.
The District Court denied the injunction request by order on April 23, 1996. On
April 16, 1996, Mr. Schwartzberg also filed a Notice of Appeal with respect to
the injunction against him with the U. S. Court of Appeals for the Second
Circuit.

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

A report on Form 8-K was filed with the Commission on February 8, 1996
regarding improved terms of a cash merger offer from an affiliate of CAPREIT for
redemption of the Partnership's BACs, subject to BAC Holder approval, as well
as an agreement in principle to settle two purported class action suits.

A report on Form 8-K was filed with the Commission on March 22, 1996
regarding the Partnership's filing of preliminary proxy materials with the
Commission regarding the previously announced proposed merger.

All other items are not applicable.

-32-
<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 Tax Exempt
Fund III Limited Partnership

By: CRITEF III Associates Limited Partnership
General Partner

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

May 17, 1996 /s/ Richard J. Palmer
- -------------------------- ------------------------------------
Date Richard J. Palmer
Senior Vice President/Finance

Signing on behalf of the Registrant
and as Principal Accounting Officer

-33-
<PAGE>

EXHIBIT INDEX

Exhibit Page
- ------- ----------------------------
27 Financial Data Schedule Filed herewith electronically

-34-

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

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 73,762
<SECURITIES> 6,019,617
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 77,091,985
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 75,087,420
<TOTAL-LIABILITY-AND-EQUITY> 77,091,985
<SALES> 0
<TOTAL-REVENUES> 1,987,979
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 253,941
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,734,038
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,734,038
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,734,038
<EPS-PRIMARY> 0.33
<EPS-DILUTED> 0.33

</TABLE>