I'm not sure why the choice is between a more powerful cpu and air cooler vs the i5 and water cooling. If water cooling is the choice, why not water cool the i7? If air cooling is sufficient for the i7, why not the i5?
The two do game similarly, outside of a small handful that get a slight boost in performance from hyper threading. Clock for clock they're nearly the same out of the box, only 300mhz difference in clock speed between them. An i5 can easily be oc'd 300mhz to make up the speed deficit compared to the i7 with a budget air cooler. If the i7 is within the budget there's no reason not to get it.
Overclocking will help if trying to achieve the highest fps as possible going with a 144hz monitor. Some people have oc'd their 6600k and noticed their fps in csgo went from 150-200fps up closer to 300fps. Many of overclocking benefits won't be seen until later on once the cpu begins aging. An overclock can boost the speed enough to have it performing as well or slightly better than the generation of cpu that replaces it potentially giving you another year or two of useful life out of it. It's not specific to i5's though, it would apply to either the i5 or i7 if oc'd.