Well I finally bought some parts and went nuts fixing some stuff on the e28 last Wednesday. I fixed/replaced the following:

-differential mount
-pitman arms
-complete coolant flush refilled with distilled/BMW blue
-new belts
-valve adjustment
-water pump
-thermostat

Now everything was fine and dandy until I was driving around on Saturday morning. I was idling talking to my neighbor about the car and he noticed coolant was leaking quite steadily from underneath the car. As we further inspected, it was coming from the overflow hose on the expansion tank. I thought that was quite weird, especially after I thought I thoroughly bled the coolant. I went home and added more coolant because now the coolant light was on. Bled it, coolant immediatley came out of the screw. Hmm, that's odd. I parked the car for the night and came out the next morning to find that it had once again drained a lot of the coolant out the overflow hose under the drivers side door.

Now I'm thinking that since the car hasn't been serviced in quite awhile, I thought it could maybe be the expansion tank cap. Maybe it was holding correct pressure for all those years but now that I kept opening/closing the cap the last few days I disturbed some kind of seal. What say you guys?

Next I was wondering what the correct temperature level on these things is supposed to be. I thought my thermostat was bad because the coolant gauge was just slighly above the "blue" area on the gauge, but after I installed the new thermostat the needle stays in the same exact spot, a slight tick above the blue. Do you think I need a new temperature sensor or is my gauge broke?

LAst but not least, my heat only works if I put it on the "window/defrost" setting. If I want air to blow out of the vents in the cabin on the dash, nothing happens. The air only comes out of the dash vents if I put the air conditioning button on? Heater blower motor?

Thanks for any help, Andrew

noticed something similar to the coolant issue on the e23 and my e34 535. swapped caps, thermostat again on one of them (don't forget the 1/16" hole to the top), several bleeding sessions on an incline and haven't had any issues since. hopefully in your case that is all that it is. as for the heater, mine quit blowing hot and after ripping through the sword and disassembling the center console controls it turned out to be the water pump zone selector solenoids being bad. if you have no blower, I would do a search on "sword, bmw"
You are sure that it's the overflow hose and not the heater core, you should have aluminum pipes and not the plastic like the older e34's and it would be the o-rings dry rotted out

that was stupid,
re read your first line.
DUUUUUHHHHHHHHH!!!!!!!!!!!!
swap the water pump on an e28 m30!!!!!
for the heat, the blower selector switch accuates a potentiometer hunk o garbage attached to the vent coming out of the passenger side of the center console, they wear out and won't send the open command to the motor on the vane, for a quick fix, ie... colder than snot outside, slide the top and lower controls over and manually push the vane open. you might have to pull the bottom/sides section off of the console to find it. once you put the heater controls back left it will more than likely close and you will have to do it again unless you jamb something in the vent. pre 86 uses a set of switches to send the signal. and seems to hold up better in my opinion, but I've only had a couple, 12 of these.
if you get air but no heat, then check the single solenoid going to the water valve by the master cylinder bolted to the firewall.

thanks, but I figured out most of my answers here:

Do you have any advice on the coolant temperature level? Where does the needle sit on your car?

http://mye28.com/viewtopic.php?t=40729

on the M30B34's 87 and 88 over halfway between the top of the blue and the middle.
on the M30B32 83 just below the middle but goes flakey sometimes and sits in the middle of the blue. I probably need to re do the wiring to the thermostat switch under the hood.
on the M30B35's 89, both of them go to the middle and stay, unless it's below 36* or so and on the highway and then they get pretty close to halfway between the blue and middle. found this on a e32 site and saved it for myself. last winter I changed so many of them I couldn't tell you which temp thermostat is in each one but they do run the heat a little different
I should have read the mye28 post but haven't been there today.
http://i193.photobucket.com/albums/z314/uberkarldrei/gauge_overheat.jpg

on the M30B34's 87 and 88 over halfway between the top of the blue and the middle.
on the M30B32 83 just below the middle but goes flakey sometimes and sits in the middle of the blue. I probably need to re do the wiring to the thermostat switch under the hood.
on the M30B35's 89, both of them go to the middle and stay, unless it's below 36* or so and on the highway and then they get pretty close to halfway between the blue and middle. found this on a e32 site and saved it for myself. last winter I changed so many of them I couldn't tell you which temp thermostat is in each one but they do run the heat a little different
I should have read the mye28 post but haven't been there today.
http://i193.photobucket.com/albums/z314/uberkarldrei/gauge_overheat.jpg

so my 87 535is should be sitting between 135-144? If so, you think my thermostat is trashed?