DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP - Quarter Report: 2008 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarter ended September 30, 2008

OR

For the transition period from              to             

Commission file number 0-17686

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

(Exact name of registrant as specified in its charter)

1100 Main Street, Suite 1830 Kansas City, Missouri 64105

(Address of principal executive offices, including zip code)

(816) 421-7444

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Interests

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 (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller Reporting Company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

CONDENSED BALANCE SHEETS

September 30, 2008 and December 31, 2007

ASSETS

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

CONDENSED BALANCE SHEETS

September 30, 2008 and December 31, 2007

LIABILITIES AND PARTNERS’ CAPITAL

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

CONDENSED STATEMENT OF (LOSS) INCOME

For the Three and Nine Month Periods Ended September 30, 2008 and 2007

(Unaudited)

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

CONDENSED STATEMENTS OF CASH FLOWS

For the Nine Month Periods Ended September 30, 2008 and 2007

(Unaudited)

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

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DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

NOTES TO CONDENSED FINANCIAL STATEMENTS

These unaudited interim condensed financial statements should be read in conjunction with DiVall Insured Income Properties 2 Limited Partnership’s (the “Partnership”) 2007 annual audited financial statements within Form 10-K.

These unaudited condensed financial statements include all adjustments, which are in the opinion of management, necessary to present a fair statement of the Partnership’s financial position as of September 30, 2008 and December 31, 2007, and the statements of income for the three and nine month periods ended September 30, 2008 and 2007, and cash flows for the nine month periods ended September 30, 2008 and 2007.

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:

DiVall Insured Income Properties 2 Limited Partnership was formed on November 18, 1987, pursuant to the Uniform Limited Partnership Act of the State of Wisconsin. The initial capital, contributed during 1987, consisted of $300, representing aggregate capital contributions of $200 by the former general partners and $100 by the Initial Limited Partner. The minimum offering requirements were met and escrowed subscription funds were released to the Partnership as of April 7, 1988. On January 23, 1989, the former general partners exercised their option to increase the offering from 25,000 interests to 50,000 interests and to extend the offering period to a date no later than August 22, 1989. On June 30, 1989, the general partners exercised their option to extend the offering period to a date no later than February 22, 1990. The offering closed on February 22, 1990, at which point 46,280.3 interests had been sold, resulting in total offering proceeds of $39,358,468, net of underwriting compensation and other offering costs.

The Partnership is currently engaged in the business of owning and operating its investment portfolio of commercial real estate properties (the “Properties”). The Properties are leased on a triple net basis to, and operated by, franchisees of national, regional, and local retail chains under long-term leases. As of September 30, 2008 the lessees are primarily fast food, family style, and casual/theme restaurants, but also include a video rental store. The Partnership owned 17 investment properties, one of which was held for sale as of September 30, 2008.

The Partnership will be dissolved on November 30, 2010, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all properties of the Partnership; (b) the written determination by the General Partner that the Partnership’s assets may constitute “plan assets” for purposes of ERISA; (c) the agreement of Limited Partners owning a majority of the outstanding interests to dissolve the Partnership; or (d) the dissolution, bankruptcy, death, withdrawal, or incapacity of the last remaining General Partner, unless an additional General Partner is elected previously by a majority of the Limited Partners. During the Second Quarters of 2001, 2003, 2005 and 2007, consent solicitations were circulated (the “2001, 2003, 2005 and 2007 Consents, respectively”), which if approved would have authorized the sale of the Partnership’s assets and dissolution of the Partnership. A majority of the Limited Partners did not vote in favor of either the 2001, 2003, 2005 or 2007 Consents. Therefore, the Partnership continues to operate as a going concern.

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Significant Accounting Policies

Rental revenue from investment properties is recognized on the straight-line basis over the term of the respective lease. Percentage rents are only accrued when the tenant has reached the sales breakpoint stipulated in the lease.

Tenant accounts receivable are comprised of billed but uncollected amounts due for monthly rents and other charges, and amounts due for scheduled rent increases for which rentals have been earned and will be collected in the future under the terms of the leases. Receivables are recorded at management’s estimate of the amounts that will be collected.

As of September 30, 2008 there were no recorded values for allowance for doubtful accounts based on an analysis of specific accounts and historical experience.

The Partnership considers its operations to be in only one segment, the operation of a portfolio of commercial real estate leased on a triple net basis, and therefore no segment disclosure is made.

Depreciation of the properties and improvements are provided on a straight-line basis over the estimated useful lives of the buildings and improvements.

Deferred charges represent leasing commissions paid when properties are leased and upon the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the term of the lease. As of September 30, 2008 and December 31, 2007, accumulated amortization amounted to $46,808 and $57,056, respectively (includes amounts included in properties held for sale at September 30, 2008).

Property taxes, insurance and ground rent on the Partnership’s investment properties are the responsibility of the tenant. However, when a tenant fails to make the required tax payments or when a property becomes vacant (such as the Park Forest, IL property formerly operated as a Popeye’s Famous Fried Chicken restaurant), the Partnership makes the appropriate payments to avoid possible foreclosure of the property. Such taxes, insurance and ground rent are accrued in the period in which the liability is incurred. The Partnership owns one (1) restaurant, which is located on a parcel of land where it has entered into a long-term ground lease. The tenant, Kentucky Fried Chicken, is responsible for the $3,400 per month ground lease payment.

Cash and cash equivalents include cash on deposit with financial institutions and highly liquid temporary investments with initial maturities of 90 days or less.

Financial instruments that potentially subject the Partnership to significant concentrations of credit risk consist primarily of cash investments and leases. The Partnership generally maintains cash and cash equivalents in federally insured accounts, which, at times, may exceed federally insured limits. The Partnership has not experienced any losses in such accounts and does not believe it is exposed to any significant credit risk. Additionally, as of September 30, 2008, nine (9) of the Partnership’s seventeen (17) properties are leased to two (2) significant tenants who comprised 42% and 18%, respectively, of the total 2007 operating base rents. The percentage calculation does not include income from properties held for sale at September 30, 2008 or sold during 2008 and 2007.

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

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Assets are classified as held for sale, generally, upon management signing a marketing contract with a broker or a sales agreement with a buyer, whichever comes sooner.

Assets disposed of or deemed to be classified as held for sale require the reclassification of current and previous years’ operations to discontinued operations in accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). As such, prior year operating results for those properties considered as held for sale or properties no longer considered for sale have been reclassified to conform to the current year presentation without effecting total income.

The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, a provision for possible loss is recognized, if any. The carrying amount of the vacant Park Forest, IL property was reduced by $267,186 to its estimated fair market value of $50,000 at September 30, 2008.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurement. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. Under SFAS No. 157, fair value measurements are disclosed by level within that hierarchy. This Statement is effective for fiscal years beginning after November 15, 2007. [SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, except for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis for which delayed application is permitted until fiscal years beginning after November 15, 2008. The Partnership’s adoption of SFAS No. 157 did not have a material impact on the Partnership’s financial position, results of operations or cash flows.

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. The standard also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Partnership has not elected to report any of its assets or liabilities at fair value as allowed by SFAS No. 159.

No provision for federal income taxes has been made, as any liability for such taxes would be that of the individual partners rather than the Partnership. At December 31, 2007 the tax basis of the Partnership’s assets exceeded the amounts reported in the December 31, 2007 financial statements by approximately $6,843,857.

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In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Partnership’s adoption of FIN 48, effective January 1, 2007, did not have a material impact on its financial statements.

Recent Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (FAS 141(R)). This Statement provides greater consistency in the accounting and financial reporting for business combinations. FAS 141(R) establishes new disclosure requirements and, among other things, requires the acquiring entity in a business combination to record contingent consideration payable, to expense transaction costs, and to recognize all assets acquired and liabilities assumed at acquisition-date fair value. This standard is effective for the beginning of the Partnership’s first fiscal year beginning after December 15, 2008. FAS 141(R) will have a significant impact on the accounting for any future business combinations after the effective date and will impact financial statements both on the acquisition date and subsequent periods.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (FAS 160). FAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to establish accounting and reporting standards for the minority or noncontrolling interests in a subsidiary or variable interest entity and for the deconsolidation of a subsidiary or variable interest entity. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. It also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. FAS 160 is effective for the beginning of the Partnership’s first fiscal year beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. Since the Partnership owns 100% of the Properties, the Partnership does not expect the adoption of this standard to have a material impact on its financial position or results of operations.

2. REGULATORY INVESTIGATION:

A preliminary investigation during 1992 by the Office of Commissioner of Securities for the State of Wisconsin and the Securities and Exchange Commission (the “Investigation”) revealed that during at least the four years ended December 31, 1992, the former general partners of the Partnership, Gary J. DiVall (“DiVall”) and Paul E. Magnuson (“Magnuson”) had transferred substantial cash assets of the Partnership and two affiliated publicly registered partnerships, DiVall Insured Income Fund Limited Partnership (“DiVall 1”) and DiVall Income Properties 3 Limited Partnership (“DiVall 3”) (collectively the “Partnerships”) to various other entities previously sponsored by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers were in violation of the respective Partnership Agreements and resulted, in part, from material weaknesses in the internal control systems of the Partnerships.

Subsequent to discovery, and in response to the regulatory inquiries, a third-party Permanent Manager, The Provo Group, Inc. (“TPG”), was appointed (effective February 8, 1993) to assume responsibility for daily operations and assets of the Partnerships as well as to develop and execute a plan of restoration for the Partnerships. Effective May 26, 1993, the Limited Partners, by written consent of a majority of interests, elected the Permanent Manager, TPG, as General Partner. TPG terminated the former general partners by accepting their tendered resignations.

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In 1993, the current General Partner estimated an aggregate recovery of $3 million for the Partnerships. At that time, an allowance was established against amounts due from former general partners and their affiliates reflecting the estimated $3 million receivable. This net receivable was allocated among the Partnerships based on each Partnership’s pro rata share of the total misappropriation, and restoration costs and recoveries have been allocated based on the same percentage. Through September 30, 2008, $5,882,000 of recoveries have been received which exceeded the original estimate of $3 million. As a result, from January 1, 1996 through September 30, 2008, the Partnership has recognized a total of $1,194,000 as recovery of amounts previously written off in the statements of income, which represents its share of the excess recovery. The current General Partner continues to pursue recoveries of the misappropriated funds, however, no further significant recoveries are anticipated.

3. INVESTMENT PROPERTIES and PROPERTIES HELD FOR SALE:

The total cost of the investment properties and specialty leasehold improvements includes the original purchase price plus acquisition fees and other capitalized costs paid to an affiliate of the former general partners.

As of September 30, 2008, the Partnership owned 15 fully constructed fast-food restaurants, a video store and one vacant property located in Park Forest, IL which was formerly operated as a Popeye’s Famous Fried Chicken restaurant (tenant ceased operations in June of 2008, and the lease was terminated and the property vacated in July of 2008). The 16 properties with operating tenants are composed of the following: nine (9) Wendy’s restaurants, one (1) Denny’s restaurant (reclassified to a property held for sale in January of 2008 and then reclassified to an investment property at September 30, 2008), one (1) Applebee’s restaurant, one (1) Kentucky Fried Chicken restaurant, one (1) Chinese Super Buffet restaurant (reclassified to a property held for sale in March of 2008 and then reclassified to an investment property in June of 2008), one (1) Panda Buffet restaurant, one (1) Daytona‘s All Sports Café, and one (1) Blockbuster Video store (reclassified to a property held for sale in May of 2007). The 17 properties are located in a total of nine (9) states.

On January 1, 2002, the Partnership adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement requires current and historical results from operations for disposed properties and assets classified as held for sale that occur subsequent to January 1, 2002 to be reclassified separately as discontinued operations. This statement also requires the adjustment to carrying value of properties due to impairment in an attempt to reflect appropriate market values.

The Partnership has been unsuccessful in finding a new tenant for the vacant Park Forest, IL property. The Partnership agreed to sell the property for $50,000 to a prospective purchaser. Negotiations ended due to uncertainty over 2008 real estate tax obligations due in 2009. The Partnership has no other interested parties for this vacant property in a distressed location. Accordingly, the carrying value of the vacant Park Forest, IL property was reduced by $276,186 to its estimated fair market value of $50,000 at September 30, 2008. The reduction included $129,450 related to land and $137,736 related to buildings.

During the three month periods ended September 30, 2008 and 2007, the Partnership recognized income from discontinued operations of approximately $23,000 and $30,000 respectively. The Partnership recognized income from discontinued operations of approximately $803,000 and $1,016,000, for the nine month periods ended September 30, 2008 and 2007, respectively. The 2008 and 2007 income from discontinued operations is attributable to the reclassification of the Wendy’s- 1515 Savannah Hwy. property to a property held for sale in the First Quarter of 2007 (the property was sold in May of 2008) and the Blockbuster, Ogden, UT property to a property held for sale in the Second Quarter of 2007 (sales contract was then executed in September of 2008). The Second Quarter of 2008 income from discontinued operations includes the $659,000 net gain on the sale of the Wendy’s- 1515 Savannah Hwy., Charleston, SC property. The property was sold in May of 2008 under the terms of the Sales Contract dated April 10, 2008. The 2008 income from discontinued operations also includes the First Quarter of 2008 collection of $25,000 in earnest money in relation to the termination of the Wendy’s- Savannah Hwy., Charleston, SC property sales contract dated August 21, 2007. The 2007 income from discontinued operations is also attributable to the Sunrise Preschool property, which was reclassified to a property held for sale in the Second Quarter of 2006 and sold in April of 2007 (the net gain on the sale of the property was approximately $862,000).

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The components of property(ies) held for sale in the condensed balance sheets as of September 30, 2008 and December 31, 2007 are outlined below:

The components of income from discontinued operations included in the condensed statement of income for the three and nine month periods ended September 30, 2008 and 2007 are outlined below (Professional service fees of approximately $600 incurred in the First Quarter of 2008 were reclassified to net gain on sale of property due to the sale of the Wendy’s- Savannah Hwy. property in May of 2008. Professional service fees of approximately $7,000 incurred in the First Quarter of 2007 were reclassified to net gain on sale of property in the Second Quarter of 2007 due to the sale of the Sunrise property in April of 2007):

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The Denny’s- Northern, Phoenix, AZ property was reclassified to a property held for sale in January of 2008, due to the execution of a listing agreement with an unaffiliated broker. A sales contract was executed on March 5, 2008 for the sale of the Denny’s- Phoenix, AZ property to an unaffiliated party. In early May, the buyer of the property withdrew from the sales contract dated March 5, 2008 due to financing difficulties. In addition, the listing agreement with the unaffiliated broker for the sale of the property expired in the Second Quarter of 2008. As of June 30, 2008, Management continued to hold the property for sale as they were pursuing other options for its potential sale. However, the property was reclassified to an investment property as of September 30, 2008, as Management has determined that options for its sale would not be actively pursued. The net book value of the buildings as shown in the condensed balance sheets at September 30, 2008, was adjusted in the Third Quarter of 2008 by $8,664 for the depreciation during the nine months the property was held for sale.

The components of the Denny’s- Northern, Phoenix, AZ property held for sale, that were included in the condensed balance sheets as of March 31, 2008, June 30, 2008 and December 31, 2007 are outlined below:

The components of the Denny’s- Northern, Phoenix, AZ property’s income from discontinued operations included in the condensed income statement for the three months periods ending March 31, 2007 and 2008, and the three and six month periods ending June 30, 2008 and 2007 are outlined below (these amounts are included in income from continuing operations for the nine month periods ending September 30, 2007 and 2008):

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The Chinese Super Buffet, Phoenix, AZ property was reclassified to a property held for sale in March of 2008 due to the execution of a sales contract with an unaffiliated party. The potential buyer terminated the contract in early June of 2008 due to difficulties in obtaining a tenant lease termination. The property was reclassified to an investment property as of June 30, 2008, as the Partnership is not currently pursuing other options for its sale. The net book value of the buildings as shown in the condensed balance sheets at June 30, 2008, was adjusted in the Second Quarter of 2008 by $2,848 for the depreciation during the months the property was held for sale.

The components of the Chinese Super Buffet, Phoenix, AZ property held for sale, that were included in the condensed balance sheets as of March 31, 2008 and December 31, 2007 are outlined below:

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The components of the Chinese Super Buffet, Phoenix, AZ property’s income from discontinued operations included in the condensed income statement for the three month periods ending March 31, 2008 and 2007 are outlined below (these amounts are included in income from continuing operations for the nine month periods ending September 30, 2007 and 2008):

Other Investment in Properties Information

According to the Partnership Agreement, the former general partners were to commit 80% of the original offering proceeds to investment in properties. Upon the close of the offering, approximately 75% of the original proceeds were invested in the Partnership’s properties.

The General Partner is not aware of any unfavorable purchase options in relation to the original cost or fair market value of the property at the time the option was granted, contained in any of the Partnership’s existing leases. Certain leases provide the tenant with the option to acquire the property occupied by the tenant.

4. PARTNERSHIP AGREEMENT:

The Partnership Agreement, prior to an amendment effective May 26, 1993, provided that, for financial reporting and income tax purposes, net profits or losses from operations were allocated 90% to the Limited Partners and 10% to the general partners. The Partnership Agreement also provided for quarterly cash distributions from Net Cash Receipts, as defined, within 60 days after the last day of the first full calendar quarter following the date of release of the subscription funds from escrow, and each calendar quarter thereafter, in which such funds were available for distribution with respect to such quarter. Such distributions were to be made 90% to Limited Partners and 10% to the former general partners, provided, however, that quarterly distributions were to be cumulative and were not to be made to the former general partners unless and until each Limited Partner had received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined.

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Net Proceeds, as originally defined, were to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation date including in the calculation of such return all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause; and (c) then, to Limited Partners, 90% and to the General Partners, 10%, of the remaining Net Proceeds available for distribution.

On May 26, 1993, pursuant to the results of a solicitation of written consents from the Limited Partners, the Partnership Agreement was amended to replace the former general partners and amend various sections of the agreement. The former general partners were replaced as General Partner by The Provo Group, Inc., an Illinois corporation. Under the terms of the amendment, net profits or losses from operations are allocated 99% to the Limited Partners and 1% to the current General Partner. The amendment also provided for distributions from Net Cash Receipts to be made 99% to Limited Partners and 1% to the current General Partner, provided that quarterly distributions are cumulative and are not to be made to the current General Partner unless and until each Limited Partner has received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined, except to the extent needed by the General Partner to pay its federal and state income taxes on the income allocated to it attributable to such year. Distributions paid to the General Partner are based on the estimated tax liability resulting from allocated income. Subsequent to the filing of the General Partner’s income tax returns, a true up with actual distributions is made.

The provisions regarding distribution of Net Proceeds, as defined, were also amended to provide that Net Proceeds are to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation Date including in the calculation of such return on all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause, except to the extent needed by the General Partner to pay its federal and state income tax on the income allocated to it attributable to such year; and (c) then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net Proceeds available for distribution.

Additionally, per the amendment of the Partnership Agreement dated May 26, 1993, the total compensation paid to all persons for the sale of the investment properties is limited to a competitive real estate commission, not to exceed 6% of the contract price for the sale of the property. The General Partner may receive up to one-half of the competitive real estate commission, not to exceed 3%, provided that the General Partner provides a substantial amount of services in the sales effort. It is further provided that a portion of the amount of such fees payable to the General Partner is subordinated to its success in recovering the funds misappropriated by the former general partners. (See Note 7.)

Effective June 1, 1993, the Partnership Agreement was amended to (i) change the definition of “Distribution Quarter” to be consistent with calendar quarters, and (ii) change the distribution provisions to subordinate the General Partner’s share of distributions from Net Cash Receipts and Net Proceeds, except to the extent necessary for the General Partner to pay its federal and state income taxes on Partnership income allocated to the General Partner. Because these amendments do not adversely affect the rights of the Limited Partners, pursuant to section 10.2 of the Partnership Agreement, the General Partner made the amendments without a vote of the Limited Partners.

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5. LEASES:

Original lease terms for the majority of the investment properties are generally 5 - 20 years from their inception. The leases generally provide for minimum rents and additional rents based upon percentages of gross sales in excess of specified sales breakpoints. The lessee is responsible for occupancy costs such as maintenance, insurance, real estate taxes, and utilities. Accordingly, these amounts are not reflected in the statements of income except in circumstances where, in management’s opinion, the Partnership will be required to pay such costs to preserve its assets (i.e., payment of past-due real estate taxes). Management has determined that the leases are properly classified as operating leases; therefore, rental income is reported when earned on a straight-line basis and the cost of the property, excluding the cost of the land, is depreciated over its estimated useful life.

As of September 30, 2008, the aggregate minimum operating lease payments to be received under the current operating leases for the Partnership’s properties are as follows (does not include the $219,000 related to the Blockbuster, Ogden, UT property which was classified as a property held for sale at September 30, 2008, the $32,000 related to the Wendy’s- Savannah Hwy., Charleston, SC property sold in May of 2008, or the $39,000 related to the vacant Park Forest, IL property). (For further disclosure see Investment Properties in Note 3, Contingency Sales in Note 10 and Investment Properties in Part I- Item 2.)

Operating percentage rentals included in operating rental income for the nine month periods ended September 30, 2008 and 2007 were approximately $191,000 and $189,000, respectively. At September 30, 2008, rents and other receivables included $182,000 of unbilled 2008 percentage rents.

Operating percentage rentals included in rental income from operations in 2007 (does not include income from properties held for sale at September 30, 2008 or properties sold during 2007 or 2008) was approximately $444,000. At December 31, 2007, rents and other receivables included $9,000 of billed and $415,000 of unbilled 2007 percentage rents. As of September 30, 2008, only approximately $3,000 of these 2007 percentage rents had not been collected (the amount was related to the Denny’s- Northern, Phoenix, AZ property and was written-off as uncollectible in the Third Quarter of 2008).

On September 4, 2008, three (3) of the properties were leased to Wendcharles I, LLC (“Wendcharles”), a franchisee of Wendy’s restaurants. On July 2, 2007, six (6) of the properties were leased to Wendgusta, LLC (“Wendgusta”), a franchisee of Wendy’s restaurants. Wendcharles and Wendgusta operating base rents accounted for 18% and 42%, respectively, of the total 2007 operating base rents. In each case, the percentage calculation does not include income from properties held for sale at September 30, 2008 or sold during 2008 and 2007.

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6. TRANSACTIONS WITH CURRENT GENERAL PARTNER AND ITS AFFILIATES:

Pursuant to the terms of the Permanent Manager Agreement (“PMA”), the General Partner receives a Base Fee for managing the Partnership equal to 4% of gross receipts, subject to a $159,000 minimum. The PMA also provides that the Partnership is responsible for reimbursement for office rent and related office overhead (“Expenses”) up to a maximum of $13,250. Both the Base Fee and Expense reimbursement are subject to annual Consumer Price Index based adjustments. Effective March 1, 2008, the minimum annual Base Fee and the maximum Expense reimbursement increased by 2.85%, which represents the allowable annual Consumer Price Index adjustment per the PMA. Therefore, as of March 1, 2008, the minimum monthly Base Fee paid by the Partnership was raised to $19,485 and the maximum monthly Expense reimbursement was raised to $1,572.

For purposes of computing the 4% overall fee, gross receipts includes amounts recovered in connection with the misappropriation of assets by the former general partners and their affiliates. To date, TPG has received fees from the Partnership totaling $58,521 on the amounts recovered, which includes fees received for the nine month periods ended September 30, 2008 and 2007 of $373 and $373, respectively. The fees received from the Partnership on the amounts recovered reduce the 4% minimum fee by that same amount.

Amounts paid and/or accrued to the current General Partner and its affiliates for the three and nine month periods ended September 30, 2008 and 2007 are as follows:

7. CONTINGENT LIABILITIES:

According to the Partnership Agreement, as amended, the current General Partner may receive a disposition fee not to exceed 3% of the contract price of the sale of investment properties. Fifty percent (50%) of all such disposition fees earned by the current General Partner is to be escrowed until the aggregate amount of recovery of the funds misappropriated from the Partnerships by the former general partners is greater than $4,500,000. Upon reaching such recovery level, full disposition fees will thereafter be payable and fifty percent (50%) of the previously escrowed amounts will be paid to the current General Partner. At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining escrowed disposition fees shall be paid to the current General Partner. If such levels of recovery are not achieved, the current General Partner will contribute the amounts escrowed towards the recovery. In lieu of an escrow, 50% of all such disposition fees have been paid directly to a restoration account and then distributed among the three original Partnerships. Fifty percent (50%) of the total amount paid to the restoration account was refunded to the current General Partner during March 1996 after exceeding the recovery level of $4,500,000. The General Partner does not expect any future refunds, as the possibility of achieving the $6,000,000 recovery threshold appears remote.

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8. PMA INDEMNIFICATION TRUST:

The PMA provides that the Permanent Manager will be indemnified from any claims or expenses arising out of or relating to the Permanent Manager serving in such capacity or as substitute general partner, so long as such claims do not arise from fraudulent or criminal misconduct by the Permanent Manager. The PMA provides that the Partnership fund this indemnification obligation by establishing a reserve of up to $250,000 of Partnership assets which would not be subject to the claims of the Partnership’s creditors. An Indemnification Trust (“Trust”) serving such purposes has been established at United Missouri Bank, N.A. The corpus of the Trust has been fully funded with Partnership assets as of September 30, 2008. Funds are invested in U.S. Treasury securities. In addition, $197,406 of earnings has been credited to the Trust as of September 30, 2008. The rights of the Permanent Manager to the Trust shall be terminated upon the earliest to occur of the following events: (i) the written release by the Permanent Manager of any and all interest in the Trust; (ii) the expiration of the longest statute of limitations relating to a potential claim which might be brought against the Permanent Manager and which is subject to indemnification; or (iii) a determination by a court of competent jurisdiction that the Permanent Manager shall have no liability to any person with respect to a claim which is subject to indemnification under the PMA. At such time as the indemnity provisions expire or the full indemnity is paid, any funds remaining in the Trust will revert back to the general funds of the Partnership.

9. FORMER GENERAL PARTNERS’ CAPITAL ACCOUNTS:

The capital account balance of the former general partners as of May 26, 1993, the date of their removal as general partners, was a deficit of $840,229. At December 31, 1993, the former general partners’ deficit capital account balance in the amount of $840,229 was reallocated to the Limited Partners.

10. CONTINGENCY SALES

Blockbuster- Odgen, UT Property

A sales contract was executed on September 26, 2008 for the sale of the Blockbuster property to an unaffiliated party for $1,075,000. Total sales commissions of 6% are anticipated to be paid upon the sale, which includes a 2% commission to a General Partner affiliate. Closing is anticipated to be late in the Fourth Quarter of 2008. The net book value of the property at September 30, 2008, classified as property held for sale in the condensed financial statements, amounted to approximately $404,000, and included $194,000 related to land, $201,000 related to buildings and improvements, $2,000 related to deferred rent, and $7,000 related to deferred charges.

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A letter of Tenant’s Right of First Refusal was mailed to the tenant, Blockbuster, on September 29, 2008 in accordance with the lease. In their response letter dated October 9, 2008, Blockbuster elected not to purchase the property at this time.

11. SUBSEQUENT EVENTS:

On November 14, 2008, the Partnership is scheduled to make distributions to the Limited Partners of $300,000, amounting to approximately $6.48 per Unit Interest.

Liquidity and Capital Resources:

Investment Properties and Net Investment in Direct Financing Leases

The Properties held by the Partnership at September 30, 2008 (does not include properties shown as held for sale in the condensed financial statements at September 30, 2008), were originally purchased at a price, including acquisition costs, of approximately $12,240,768.

The total cost of the investment properties and specialty leasehold improvements includes the original purchase price plus acquisition fees and other capitalized costs paid to an affiliate of the former general partners.

As of September 30, 2008, the Partnership owned 15 fully constructed fast-food restaurants, a video store and one vacant property located in Park Forest, IL which was formerly operated as a Popeye’s Famous Fried Chicken restaurant (tenant ceased operations in June of 2008, and the lease was terminated and the property vacated in July of 2008). The 16 properties with operating tenants are composed of the following: nine (9) Wendy’s restaurants, one (1) Denny’s restaurant (reclassified to a property held for sale in January of 2008 and then reclassified to an investment property in September of 2008), one (1) Applebee’s restaurant, one (1) Kentucky Fried Chicken restaurant, one (1) Chinese Super Buffet restaurant (reclassified to a property held for sale in March of 2008 and then reclassified to an investment property in June of 2008), one (1) Panda Buffet restaurant, one (1) Daytona’s All Sports Café, and one (1) Blockbuster Video store (reclassified to property held for sale in May of 2007). The 17 properties are located in a total of nine (9) states.

Six (6) of the seventeen (17) properties owned as of September 30, 2008 were leased to Wendgusta, LLC (“Wendgusta”). Since more than 20% of the Partnership’s properties, both by asset value and number, are leased to a single tenant, the financial status of the tenant may be considered relevant to investors. Wendgusta was formed during 2007, and at the request of the Partnership, Wendgusta provided it with copies of Wendgusta’s reviewed financial statements for the period May 16 to December 30, 2007. Those reviewed financial statements are attached to the March 31, 2008 Quarterly Report 10-Q as Exhibit 99.1. These financial statements were prepared by Wendgusta’s accountants. The Partnership has no rights to audit Wendgusta and no right to dictate the form of the financials provided by Wendgusta. The Partnership’s auditors have not audited or reviewed the financial statements received from Wendgusta. The Partnership has no reason to believe the Wendgusta financial statements do not accurately reflect the financial position of Wendgusta.

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Three (3) of the seventeen (17) properties owned as of September 30 2008, which amounts to approximately 18% of the total number of properties, were leased to Wendcharles I, LLC (“Wendcharles”). Since Wendcharles was formed during 2008, no audited financial statements are available as of September 30, 2008. The leases of these three (3) properties were assumed and assigned by Wendcharles from Wencoast Restaurants, Inc. (“Wencoast”) on September 4, 2008. At the request of the Partnership, Wencoast provided it with copies of Wencoast’s most recent available audited financial statements for the periods ended January 1, 2006 and December 31, 2006. Those audited financial statements are attached to the December 31, 2007 Annual Report 10-K as Exhibit 99.1. These financial statements were prepared by Wencoast’s auditors. The Partnership has no rights to audit Wencoast and no right to dictate the form of the audited financials provided by Wencoast. The Partnership’s auditors have not audited or reviewed the financial statements received from Wencoast. The Partnership has no reason to believe the Wencoast financial statements do not accurately reflect the financial position of Wencoast.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” current and historical results from operations for disposed properties and assets classified as held for sale that occur subsequent to January 1, 2002 are reclassified separately as discontinued operations. This statement also requires the adjustment to carrying value of properties due to impairment in an attempt to reflect appropriate market values.

The Partnership has been unsuccessful in finding a new tenant for the vacant Park Forest, IL property. The Partnership agreed to sell the property for $50,000 to a prospective purchaser. Negotiations ended due to uncertainty over 2008 real estate tax obligations due in 2009. The Partnership has no other interested parties for this vacant property in a distressed location. Accordingly, the carrying value of the vacant Park Forest, IL property was reduced by $276,186 to its fair market value of $50,000 at September 30, 2008. The reduction included $129,450 related to land and $137,736 related to buildings and improvements.

During the three month periods ended September 30, 2008 and 2007, the Partnership recognized income from discontinued operations of approximately $23,000 and $30,000 respectively. The Partnership recognized income from discontinued operations of approximately $803,000 and $1,016,000, for the nine month periods ended September 30, 2008 and 2007, respectively. The 2008 and 2007 income from discontinued operations is attributable to the reclassification of the Wendy’s- 1515 Savannah Hwy. property to a property held for sale in the First Quarter of 2007 (the property was sold in May of 2008), and the Blockbuster, Ogden, UT property to a property’s held for sale in the Second Quarter of 2007 (sales contract was executed in September of 2008). The Second Quarter of 2008 income from discontinued operations includes the $659,000 net gain on the sale of the Wendy’s- 1515 Savannah Hwy., Charleston, SC property. The property was sold in May of 2008 under the terms of the Sales Contract dated April 10, 2008. The 2008 income from discontinued operations also includes the First Quarter of 2008 collection of $25,000 in earnest money in relation to the termination of the Wendy’s- Savannah Hwy., Charleston, SC property sales contract dated August 21, 2007. The 2007 income from discontinued operations is also attributable to the Sunrise Preschool property, which was reclassified to a property held for sale in the Second Quarter of 2006 and sold in April of 2007 (the net gain on the sale of the property was approximately $862,000).

The Denny’s- Northern, Phoenix, AZ property was reclassified to a property held for sale in January of 2008, due to the execution of a listing agreement with an unaffiliated broker. A sales contract with an unaffiliated party was then executed in March of 2008. The potential buyer terminated the contract in early May of 2008 due to financing difficulties. Although the listing agreement had expired, Management continued to hold the property for sale at June 30, 2008, as other options for the sale of the property were being pursued.

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However, the property was reclassified to an investment property in September of 2008, as Management does not currently plan to actively pursue options for its sale. The net book value of the property at March 31, 2008, classified as property held for sale in the condensed financial statements, was approximately $593,000, which included $453,000 related to land, $140,000 related to buildings and improvements, $2,000 related to deferred rent, $4,000 related to rent and other receivables, and $6,000 related to unearned rental income. The net book value of the property at June 30, 2008, classified as property held for sale in the condensed financial statements, was approximately $600,000, which included $453,000 related to land, $140,000 related to buildings and improvements, $2,000 related to deferred rent and $5,000 related to rent and other receivables. The net book value of the buildings as shown in the condensed balance sheets at September 30, 2008, was adjusted in the Third Quarter of 2008 by $8,664 for the depreciation during the months the property was held for sale. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the three month periods ending March 31, 2008 and 2007 were $16,000 and $12,000, respectively. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the three month periods ending June 30, 2008 and 2007 were $15,000 and $12,000, respectively. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the six month periods ending June 30, 2008 and 2007 were $3,000 and $24,000, respectively. These amounts were included in income from continuing operations for the nine month periods ending September 30, 2007 and 2008.

The Chinese Super Buffet, Phoenix, AZ property was reclassified to a property held for sale in March of 2008 due to the execution of a sales contract with an unaffiliated party. The potential buyer terminated the contract in early June of 2008 due to difficulties in obtaining a tenant lease termination. The property was therefore reclassified to an investment property in June of 2008, as the Partnership is not currently pursuing other options for its sale. The net book value of the property at March 31, 2008, classified as property held for sale in the condensed financial statements, was approximately $628,000, which included $444,000 related to land, $133,000 related to buildings and improvements, $28,000 related to deferred rent and $23,000 related to deferred charges. The net book value of the buildings as shown in the condensed balance sheets at June 30, 2008, was adjusted in the Second Quarter of 2008 by $2,848 for the depreciation during the months the property was held for sale. The Chinese Super Buffet property’s income from discontinued operations included in the condensed income statement for the three month periods ending March 31, 2008 and 2007 were $11,000 and $13,000, respectively. These amounts were included in income from continuing operations for the six and nine month periods ending June 30, and September 30, 2007 and 2008.

The following summarizes significant developments, by property, for properties with such developments.

Blockbuster- Ogden, UT Property

In early May of 2008, the listing agreement for the sale of the property that was executed with an unaffiliated broker in December of 2007 was extended six months. A sales contract was then executed on September 26, 2008 for the sale of the Blockbuster property to an unaffiliated party for $1,075,000. Total sales commissions of 6% are anticipated to be paid upon the sale, which includes a 2% commission to a General Partner affiliate. Closing is anticipated to be late in the Fourth Quarter of 2008. The net book value of the property at September 30, 2008, classified as property held for sale in the condensed financial statements, amounted to approximately $404,000, and included $194,000 related to land, $201,000 related to buildings and improvements, $2,000 related to deferred rent, and $7,000 related to deferred charges.

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A letter of Tenant’s Right of First Refusal was mailed to the tenant, Blockbuster, on September 29, 2008 in accordance with the lease. In their response letter dated October 9, 2008, Blockbuster elected not to purchase the property at this time.

In February of 2008, Management executed a one-year lease extension agreement with Blockbuster. The lease was set to expire on January 31, 2009 and included annual base rent of $108,000 and a rent abatement of $6,000 for the month of February 2008. Commissions of approximately $5,000 ($2,000 to a non-affiliated broker and $3,000 to a General Partner affiliate) were paid and or accrued in the First Quarter of 2008. In August of 2008, Management executed a one-year lease extension agreement with Blockbuster. The lease extension, which begins on February 1, 2009 and expires on January 31, 2010, includes an annual base rent of $108,000. Commissions of approximately $5,000 ($2,000 to a non-affiliated broker and $3,000 to a General Partner affiliate) were paid/and or accrued in the Third Quarter of 2008.

Wendy’s- 347 Folly Road, Charleston, SC

The Folly Road property lease with tenant, Wencoast, was set to expire on November 6, 2016. On September 4, 2008 the lease was assumed and assigned to Wendcharles. Per the Assumption and Assignment of Lease agreement, the monetary lease obligations and original lease expiration date remained the same. However, per a Lease Amendment agreement (“Amendment”) with Wendcharles, dated September 4, 2008, the original lease was extended five (5) years to November 6, 2021. The Amendment also includes two five year lease option renewals, a $100,000 capital improvement investment in the property by Wendcharles within 24 months (September 2010), and an additional $50,000 capital improvement investment in the property by Wendcharles if the tenant exercises the second five (5) year lease extension option. A leasing commission of approximately $11,000 was paid to a General Partner affiliate in the Third Quarter in relation to the five year lease extension.

Wendy’s- 361 Hwy. 17 Bypass, Mt. Pleasant, SC

The Hwy. 17 Bypass property lease with tenant, Wencoast, was set to expire on November 6, 2016. On September 4, 2008 the lease was assumed and assigned to Wendcharles. Per the Assumption and Assignment of Lease agreement, the monetary lease obligations and original lease expiration date remained the same. However, per a Lease Amendment agreement (“Amendment”) with Wendcharles, dated September 4, 2008, the original lease was extended five (5) years to November 6, 2021. The Amendment also includes two five year lease option renewals, a $120,000 capital improvement investment in the property by Wendcharles within 24 months (September 2010), and an additional $50,000 capital improvement investment in the property by Wendcharles if the tenant exercises the second five (5) year lease extension option. A leasing commission of approximately $12,000 was paid to a General Partner affiliate in the Third Quarter in relation to the five year lease extension.

Wendy’s- 1721 Sam Rittenberg, Charleston, SC

The Sam Rittenberg property lease with tenant, Wencoast, was set to expire on November 6, 2016. On September 4, 2008 the lease was assumed and assigned to Wendcharles. Per the Assumption and Assignment of Lease agreement, the monetary lease obligations and original lease expiration date remained the same. However, per a Lease Amendment agreement (“Amendment”) with Wendcharles, dated September 4, 2008, the original lease was extended five (5) years to November 6, 2021. The Amendment also includes two five year lease option renewals, a $130,000 capital improvement investment in the property by Wendcharles within 24 months (September 2010), and an additional $50,000 capital improvement investment in the property by Wendcharles if the tenant exercises the second five (5) year lease extension option. A leasing commission of approximately $12,000 was paid to a General Partner affiliate in the Third Quarter in relation to the five year lease extension.

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Vacant Park Forest, IL Property

The former tenant, a Popeye’s Famous Fried Chicken restaurant, ceased its operations in June of 2008. The lease was set to expire on December 31, 2009; however, the lease was terminated and the tenant vacated the property in July of 2008. As of June 30, 2008, the former defaulted tenant owed the Partnership approximately $19,000 and $14,000 in past due billings of monthly rent and property tax escrow, respectively. The Partnership received full payment of both of these items from Popeye’s in August of 2008 in accordance with the terms of the lease termination and settlement agreement.

The Partnership has been unsuccessful in finding a new tenant for the vacant Park Forest, IL property. The Partnership agreed to sell the property for $50,000 to a prospective purchaser. Negotiations ended due to uncertainty over 2008 real estate tax obligations due in 2009. The Partnership has no other interested parties for this vacant property in a distressed location. Accordingly, the carrying value of the vacant Park Forest, IL property was reduced by $276,186 to its estimated fair market value of $50,000 at September 30, 2008. The reduction included $129,450 related to land and $137,736 related to buildings and improvements.

As of September 30, 2008, the Partnership has accrued nine months of estimated 2008 property tax related to the Park Forest, IL property, which the Partnership will be obligated to pay to the Cook County taxing authority in 2009. Due to the lease termination and settlement, such property taxes will not be collectible from the former tenant. The former tenant’s property tax escrow balance held with the Partnership as of September 30, 2008 will meet all but $1,300 of the Park Forest property’s second 2007 property tax installment due in November of 2008. The minimal shortage has been accrued and expensed by the Partnership as of September 30, 2008.

Daytona’s All Sports Café- Des Moines, IA Property

In May of 2008, Management executed a one-year lease extension agreement with Daytona’s All Sports Café (“Daytona’s”). The lease extension begins, and is effective, as of March 1, 2008. The lease, with an annual base rent of $72,000, is now set to expire on February 28, 2009. A commission of approximately $2,000 was paid to a General Partner affiliate in the Second Quarter of 2008.

Wendy’s- 1515 Savannah Hwy., Charleston, SC Property

On August 21, 2007, the Partnership executed a contract to sell the property to unaffiliated party. On February 29, 2008, the Partnership received a Notice of Termination of Contract in relation to the sale of the property. The buyer was unable to procure the necessary city building permits in the manner desired. On March 3, 2008, in accordance with the terms of the sales contract, the Partnership received the $25,000 in earnest money held with the title company.

A new sales contract was executed on April 10, 2008 for the sale of the property to a different unaffiliated party for $1.17 million. A letter of Tenant’s Right of First Refusal was mailed to the tenant, Wencoast Restaurants, Inc., on April 10, 2008 in accordance with the lease. Wencoast, who had 30 days from its receipt of the letter, did not exercise its right of first refusal.

The closing date on the sale of the property was May 28, 2008 and the net sales proceeds totaled approximately $1.09 million. A net gain on the sale of approximately $659,000 was recognized in the Second Quarter of 2008. Closing and other sale related costs amounted to approximately $80,000 and included $70,200 in sales commission, of which $35,100 was paid to a General Partner affiliate.

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Other Investment in Properties Information

According to the Partnership Agreement, the former general partners were to commit 80% of the original offering proceeds to investment in properties. Upon the close of the offering, approximately 75% of the original proceeds were invested in the Partnership’s properties.

The General Partner is not aware of any unfavorable purchase options in relation to the original cost or fair market value of the property at the time the option was granted, contained in any of the Partnership’s existing leases. Certain leases provide the tenant with the option to acquire the property occupied by the tenant.

Other Assets

Cash and cash equivalents held by the Partnership totaled approximately $651,000 at September 30, 2008, compared to $677,000 at December 31, 2007. Cash of $300,000 is anticipated to be used to fund the Third Quarter of 2008 distribution to Limited Partners in November of 2008, and cash of $68,000 is anticipated to be used for the payment of quarter-end accounts payable and other accrued expenses, and the remainder represents amounts deemed necessary to allow the Partnership to operate normally.

Cash generated through the operations of the Partnership’s Properties and sales of Properties will provide the sources for future fund liquidity and Limited Partner distributions.

The net book value of properties held for sale at September 30, 2008 amounted to approximately $404,000. A sales contract for the sale of the Blockbuster Property was executed in September of 2008 at a sales price of $1.075 million. The net book value of the Blockbuster Property at September 30, 2008, was approximately $404,000, which included $194,000 related to land, $201,000 related to buildings, $2,000 related to deferred rent and $7,000 related to deferred charges. (For further disclosure see Investment Properties in Part I- Item 2.)

Property tax cash escrow amounted to approximately $38,000 at September 30, 2008, compared to $41,000 at December 31, 2007. Daytona’s property tax cash escrow balance held with the Partnership at September 30, 2008 was approximately $12,000. Daytona’s 2006-2007 second property tax installment of approximately $11,000 was paid in the First Quarter of 2008 and its 2007-2008 first property tax installment estimate of $11,000 was paid in the Third Quarter of 2008. Former tenant, Popeye’s, property tax cash escrow balance held with the Partnership at September 30, 2008 totaled approximately $26,000. Popeye’s 2007 first property tax installment of approximately $27,000 was paid in the First Quarter of 2008 and its 2007 second property tax installment of approximately $28,000 is scheduled to be paid in November of 2008. The Partnership has accrued and expensed the minimal shortage in the former tenant’s escrow balance.

The Partnership established an Indemnification Trust (the “Trust”) during the Fourth Quarter of 1993, deposited $100,000 in the Trust during 1993 and completed funding of the Trust with $150,000 during 1994. The provision to establish the Trust was included in the Permanent Manager Agreement for the indemnification of TPG, in the absence of fraud or gross negligence, from any claims or liabilities that may arise from TPG acting as Permanent Manager. The Trust is owned by the Partnership. (For additional information regarding the Trust refer to Note 8 to the condensed financial statements- PMA Indemnification Trust.)

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Rents and other receivables amounted to approximately $189,000 at September 30, 2008, compared to $425,000 at December 31, 2007. The September 30, 2008 balance included Daytona’s outstanding September’s rent and property tax escrow obligation and approximately $182,000 in 2008 percentage rental income accrued in the Second and Third Quarters of 2008 for tenants who had reached their sales breakpoint. These percentage rents will not be billed or owed by the tenant’s until the First Quarter of 2009. The December 31, 2007, rents and other receivables primarily included approximately $425,000 in 2007 percentage rental income accrued in the Second, Third and Fourth Quarters of 2007 for tenants who had reached their sales breakpoint. These percentage rents included $9,000 which was billed to a tenant in the Fourth Quarter of 2007 and $415,000 which were not billed to or owed by the tenant’s until the First Quarter of 2008.

Property tax receivable at September 30, 2008 totaled $2,000 compared to $1,000 at December 31, 2007.

Prepaid Insurance amounted to approximately $3,000 at September 30, 2008, compared to $29,000 at December 31, 2007. The September 30, 2008 and December 31, 2007 balances represented approximately one (1) month and ten (10) months, respectively, of prepaid insurance paid by the Partnership.

Deferred charges totaled approximately $296,000, net of accumulated amortization, at September 30, 2008, compared to $268,000 at December 31, 2007. Deferred charges represent leasing commissions paid when properties are leased or upon the negotiated extension of a lease. Leasing commissions of approximately $10,000 and $2,000 have been paid in 2008 in relation to the lease term extensions of the Blockbuster and Daytona’s Properties, respectively (for further discussion see Investment in Properties in Part I- Item 2). Leasing commissions of approximately $34,000 were paid in September of 2008 in relation to the lease extensions of three (3) of the Wendy’s properties (for further discussion see Investment in Properties in Part I- Item 2). Deferred leasing commissions (net of accumulated amortization) of approximately $7,000, which are related to the Blockbuster Property, were included in properties held for sale at September 30, 2008 (for further discussion see Investment Properties in Part I- Item 2). Leasing commissions are capitalized and amortized over the life of the lease.

Liabilities

Accounts payable and other accrued expenses at September 30, 2008, amounted to approximately $68,000, compared to $99,000 at December 31, 2007. The balances primarily represented the accruals of professional, tax and data processing fees.

Property tax payable at September 30, 2008 and December 31, 2007 totaled approximately $84,000 and $42,000, respectively. The balances include Daytona’s and former tenant, Popeye’s, property tax escrow charges related to the next installments of property tax due. The 2008 balance also includes the Partnership’s accrual of nine months of 2008 property tax related to the vacant (formerly Popeye’s) Park Forest, IL property, which is to be paid by the Partnership in 2009 (for further discussion see Investment Properties in Part I- Item 2).

Income taxes payable at September 30, 2008 totaled approximately $7,000 and relates to the 2008 estimated South Carolina income tax for the sale of the Wendy’s- Savannah Hyw., Charleston, SC property in May of 2008.

Due to the Current General Partner amounted to approximately $1,601 at September 30, 2008 and primarily represented the General Partner’s Third Quarter of 2008 distribution.

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Partners’ Capital

Net income for the year to-date was allocated between the General Partner and the Limited Partners, 1% and 99%, respectively, as provided for in the Partnership Agreement as discussed more fully in Note 4 of the condensed financial statements included in Item 1 of this report. The former general partners’ deficit capital account balance was reallocated to the Limited Partners at December 31, 1993. Refer to Note 9 to the condensed financial statements included in Item 1 of this report for additional information regarding the reallocation.

Cash distributions to the Limited Partners and to the General Partner during 2008 of $2,090,000 and $5,233, respectively, have also been made in accordance with the Partnership Agreement. The Partnership intends to pay Third Quarter of 2008 distributions of $300,000 on November 14, 2008.

Results of Operations

The Partnership reported (loss) income from continuing operations for the three month periods ended September 30, 2008 and 2007, of $(22,000) and $299,000, respectively. The Partnership reported income from continuing operations for the nine month periods ended September 30, 2008 and 2007, of $178,000 and $548,000, respectively. The variance in income from continuing operations in 2008 compared to 2007 is due primarily to: (i) the $267,000 carrying value write-down of the vacant Park Forest, IL property in the Third Quarter of 2008; (ii) higher 2008 estimated income tax expenditures in 2008; (iii) the accrual of nine months of estimated 2008 property tax related to the vacant Park Forest, IL property which will be due in 2009; (iv) the vacancy of the Park Forest, IL property due to the lease termination agreement (rent ceased beginning July of 2008); (v) higher professional fees incurred during 2008 due to tenant defaults, Popeye’s lease termination and settlement, Wendy’s lease assignments, and general attorney fees for topic research; (vi) the reversal of the $12,000 2005/2006 insurance premium adjustment accrual in the First Quarter of 2008 and the reversal of the $12,000 2006/2007 insurance premium adjustment accrual in the Second Quarter of 2008; and (vii) higher interest yields recognized in the Second and Third Quarters of 2007.

Discontinued Operations

During the three month periods ended September 30, 2008 and 2007, the Partnership recognized income from discontinued operations of approximately $23,000 and $30,000 respectively. The Partnership recognized income from discontinued operations of approximately $803,000 and $1,016,000, for the nine month periods ended September 30, 2008 and 2007, respectively. The 2008 and 2007 income from discontinued operations is attributable to the reclassification of the Wendy’s- 1515 Savannah Hwy. property to a property held for sale in the First Quarter of 2007 (the property was sold in May of 2008) and the Blockbuster, Ogden, UT property to a property held for sale in the Second Quarter of 2007 (sales contract was executed in September of 2008). The Second Quarter of 2008 income from discontinued operations includes the $659,000 net gain on the sale of the Wendy’s- 1515 Savannah Hwy., Charleston, SC property. The property was sold in May of 2008 under the terms of the Sales Contract dated April 10, 2008. The 2008 income from discontinued operations also includes the First Quarter of 2008 collection of $25,000 in earnest money in relation to the termination of the Wendy’s- Savannah Hwy., Charleston, SC property sales contract dated August 21, 2007. The 2007 income from discontinued operations is also attributable to the Sunrise Preschool property, which was reclassified to a property held for sale in the Second Quarter of 2006 and sold in April of 2007 (the net gain on the sale of the property was approximately $862,000).

The Denny’s- Northern, Phoenix, AZ property was reclassified to a property held for sale in January of 2008, due to the execution of a listing agreement with an unaffiliated broker. A sales contract with an unaffiliated party was then executed in March of 2008. The potential buyer terminated the contract in early May of 2008 due to financing difficulties. Although the listing agreement had expired,

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Management continued to hold the property for sale at June 30, 2008, as other options for the sale of the property were being pursued. However, the property was reclassified to an investment property in September of 2008, as Management does not currently plan to actively pursue options for its sale. The net book value of the property at March 31, 2008, classified as property held for sale in the condensed financial statements, was approximately $593,000, which included $453,000 related to land, $140,000 related to buildings and improvements, $2,000 related to deferred rent, $4,000 related to rent and other receivables, and $6,000 related to unearned rental income. The net book value of the property at June 30, 2008, classified as property held for sale in the condensed financial statements, was approximately $600,000, which included $453,000 related to land, $140,000 related to buildings and improvements, $2,000 related to deferred rent and $5,000 related to rent and other receivables. The net book value of the buildings as shown in the condensed balance sheets at September 30, 2008, was adjusted in the Third Quarter of 2008 by $8,664 for the depreciation during the months the property was held for sale. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the three month periods ending March 31 2008 and 2007 were $16,000 and $12,000, respectively. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the three month periods ending June 30 2008 and 2007 were $15,000 and $12,000, respectively. The Denny’s- Northern property’s income from discontinued operations included in the condensed income statement for the six month periods ending June 30 2008 and 2007 were $3,000 and $24,000, respectively. These amounts were included in income from continuing operations for the nine month periods ending September 30, 2007 and 2008.

The Chinese Super Buffet, Phoenix, AZ property was reclassified to a property held for sale in March of 2008 due to the execution of a sales contract with an unaffiliated party. The potential buyer terminated the contract in early June of 2008 due to difficulties in obtaining a tenant lease termination. The property was therefore reclassified to an investment property in June of 2008, as the Partnership is not currently pursuing other options for its sale. The net book value of the property at March 31, 2008, classified as property held for sale in the condensed financial statements, was approximately $628,000, which included $444,000 related to land, $133,000 related to buildings and improvements, $28,000 related to deferred rent and $23,000 related to deferred charges. The net book value of the buildings as shown in the condensed balance sheets at June 30, 2008, was adjusted in the Second Quarter of 2008 by $2,848 for the depreciation during the months the property was held for sale. The Chinese Super Buffet property’s income from discontinued operations included in the condensed income statement for the three month periods ending March 31, 2008 and 2007 were $11,000 and $13,000, respectively. These amounts were included in income from continuing operations for the six and nine month periods ending June 30, and September 30, 2007 and 2008.

In accordance with Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144), discontinued operations represent the operations of properties disposed of or classified as held for sale subsequent to January 1, 2002 as well as any gain or loss recognized in their disposition.

Revenues

Total operating revenues amounted to $478,000 and $487,000, for the three month periods ended September 30, 2008 and 2007, respectively. Total operating revenues amounted to $1,122,000 and $1,133,000, for the nine month periods ended September 30, 2008 and 2007, respectively.

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As of September 30, 2008, total base operating rent revenues should approximate $1,155,000 for the year 2008 based on leases currently in place (does not include properties classified as held for sale at September 30, 2008, sold during 2008, or vacant at September 30, 2008). Future operating rent revenues may decrease with tenant defaults and/or the reclassification of Properties as held for sale. They may also increase with additional rents due from tenants, if those tenants experience sales levels, which require the payment of additional rent to the Partnership.

Expenses

For the three month periods ended September 30, 2008 and 2007, total operating expenses amounted to approximately 105% and 39%, respectively, of total operating revenues. For the nine month periods ended September 30, 2008 and 2007, total operating expenses amounted to approximately 84% and 52%, respectively, of total operating revenues. The variance in total operating expenses in 2008 compared to 2007 is due primarily to: (i) the $267,000 carrying value write-down of the vacant Park Forest, IL property in the Third Quarter of 2008; (ii) higher 2008 estimated income tax expenditures in 2008; (iii) the accrual of six months of estimated 2008 property tax related to the vacant Park Forest, IL property in the Second Quarter of 2008; and (iv) the reversal of the $12,000 2005/2006 insurance premium adjustment accrual in the First Quarter of 2008 and the reversal of the $12,000 2006/2007 insurance premium adjustment accrual in the Second Quarter of 2008.

Depreciation and amortization are non-cash items and do not affect current operating cash flow of the Partnership or distributions to the Limited Partners.

For the three and nine month periods ended September 30, 2008, there were approximately $5,000 in write-offs for non-collectible rents and receivables. Such write-off was the result of defaults by the former tenant of the Denny’s- Northern, Phoenix, AZ property. There were no write-offs of non-collectible rents and receivables for the three and nine-month period ended September 30, 2007.

Other Income

For the three month periods ended September 30, 2008 and 2007, the Partnership generated other income of approximately $18,000 and $25,000, respectively. For the nine month periods ended September 30, 2008 and 2007, the Partnership generated other income of approximately $59,000 and $76,000, respectively.

Other revenues came primarily from interest earnings (higher interest yields were recognized in the Second Quarter of 2007) and small recoveries from former General Partners. Management anticipates that such revenue types may continue to be generated until Partnership dissolution.

Inflation

Inflation has a minimal effect on operating earnings and related cash flows from a portfolio of triple net leases. By their nature, such leases actually fix revenues and are not impacted by rising costs of maintenance, insurance, or real estate taxes. Although the majority of the Partnership’s leases have percentage rental clauses, revenues from operating percentage rentals represented only 26% of operating rental income for the year ended 2007 (does not include operating income from properties classified as held for sale at September 30, 2008 or sold during 2007 or 2008). If inflation causes operating margins to deteriorate for lessees, or if expenses grow faster than revenues, then, inflation may well negatively impact the portfolio through tenant defaults.

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It would be misleading to associate inflation with asset appreciation for real estate, in general, and the Partnership’s portfolio, specifically. Due to the “triple-net” nature of the property leases, asset values generally move inversely with interest rates.

Critical Accounting Policies

The Partnership believes that its most significant accounting policies deal with:

Depreciation methods and lives- Depreciation of the properties is provided on a straight-line basis over 31.5 years, which is the current estimated useful life of the buildings and improvements. While the Partnership believes these are the appropriate lives and methods, use of different lives and methods could result in different impacts on net income. Additionally, the value of real estate is typically based on market conditions and property performance, so depreciated book value of real estate may not reflect the market value of real estate assets.

Revenue recognition- Rental revenue from investment properties is recognized on the straight-line basis over the life of the respective lease. Percentage rents are accrued only when the tenant has reached the sales breakpoint stipulated in the lease.

Impairment- The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, a provision for possible loss is recognized, if any.

The Partnership is not subject to market risk. See Part II, Item 1A for the discussion of Risk Factors.

Controls and Procedures

Based on their evaluation as of September 30, 2008, the Partnership’s Chief Executive Officer and Chief Financial Officer, have concluded that the Partnership’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that the information required to be disclosed by the Partnership in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and Form 10-Q.

There were no changes in our internal controls over financial reporting during the quarter ended September, 30, 2008 that have materially affected, or are reasonably likely to materially affect the Partnership’s internal controls over financial reporting.

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PART II - OTHER INFORMATION

None.

General Risks Associated With Real Estate Ownership

The Partnership is subject to all of the general risks associated with the ownership of real estate. In particular, the Partnership faces the risk that rental revenue from its Properties may be insufficient to cover all operating expenses. Additional real estate ownership risks include:

Risks Related to Tenants

The Partnership’s return on its investment will be derived principally from rental payments received from its tenants. Therefore, the Partnership’s return on its investment is largely dependent upon the business success of its tenants. The business success of the Partnership’s individual tenants can be adversely affected on three general levels. First, the tenants rely heavily on the management contributions of a few key entrepreneurial owners. The business operations of such entrepreneurial tenants can be adversely affected by death, disability or divorce of a key owner, or by such owner’s poor business decisions such as an undercapitalized business expansion. Second, changes in a local market area can adversely affect a tenant’s business operation. A local economy can suffer a downturn with high unemployment. Socioeconomic neighborhood changes can affect retail demand at specific sites and traffic patterns may change, or stronger competitors may enter a market. These and other local market factors can potentially adversely affect the tenants of Partnership properties. Finally, despite an individual tenant’s solid business plans in a strong local market, the chain concept itself can suffer reversals or changes in management policy, which in turn can affect the profitability of operations for Partnership properties. Therefore, there can be no assurance that any specific tenant will have the ability to pay its rent over the entire term of its lease with the Partnership.

Since over 90% of the Partnership’s investment in properties involves restaurant tenants, the restaurant market is the major market segment with a material impact on Partnership operations. It would appear that the management skill and potential operating efficiencies realized by Partnership lessees will be a major ingredient for their future operating success in a very competitive restaurant and food service marketplace.

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There is no way to determine, with any certainty, which, if any, tenants will succeed or fail in their business operations over the term of their respective leases with the Partnership. It can be reasonably anticipated that some lessees will default on future lease payments to the Partnership, which will result in the loss of expected lease income for the Partnership. Management will use its best efforts to vigorously pursue collection of any defaulted amounts and to protect the Partnership’s assets and future rental income potential by trying to re-negotiate leases or re-lease any properties with rental defaults. External events, which could impact the Partnership’s liquidity, are the entrance of other competitors into the market areas of our tenants; liquidity and working capital needs of the lessees; and failure or withdrawal of any of the national franchises held by the Partnership’s tenants. Each of these events, alone or in combination, would affect the liquidity level of the lessees resulting in possible default by a tenant. Since the information regarding plans for future liquidity and expansion of closely held organizations, which are tenants of the Partnership, tend to be of a private and proprietary nature, anticipation of individual liquidity problems is difficult, and prediction of future events is nearly impossible.

Illiquidity of Real Estate Investments

Because real estate investments are relatively illiquid, the Partnership is limited in its ability to quickly sell one or more Properties in response to changing economic, financial and investment conditions. The real estate market is affected by many forces, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond the Partnership’s control. There is no way to predict whether the Partnership will be able to sell any property for a price or on terms that would be acceptable to the Partnership. It is also impossible to predict the length of time needed to find a willing purchaser and to close the sale of a Property.

The Partnership May Be Subject to Unknown Environmental Liabilities

Investments in real property can create a potential for environmental liability. An owner of property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. The Partnership can face such liability regardless of the knowledge of the contamination; the timing or cause of the contamination; or the party responsible for the contamination of the property.

The presence of hazardous substances on a property may adversely affect the Partnership’s ability to sell that property and it may incur substantial remediation costs. Although the Partnership leases generally require tenants to operate in compliance with all applicable federal, state and local environmental laws, ordinances and regulations, and to indemnify the Partnership against any environmental liabilities arising from the tenants’ activities on the property, the Partnership could nevertheless be subject to strict liability by virtue of its ownership interest. There also can be no assurance that tenants could or would satisfy their indemnification obligations under their leases. The discovery of environmental liabilities attached to the Partnership’s Properties could have an adverse effect on the Partnership’s results of operations, financial condition or ability to make distributions to limited partners.

None

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The Registrant has not filed a Form 8-K in 2008.

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SIGNATURES

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

DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the Registrant and in the capacities and on the date indicated.

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