My vote goes toward the water conversion. Though you spend time routing water lines; the power is going to be more reliable as it is not stressed, it's stock. Stock rebuilds will be easier than designing a engine, cheaper too especially if you don't have the experience.
I'd go with a 13b rotary conversion, and a small turbo. This will be fast and though rotarys are not thought of as reliable; it will last 100,000 miles under boost, and give you a stock 9g rev limit. Probably looking in the range of 200hp with only three moving parts. Plus it seems easier, don't have to worry about losing parts because of break ins, lifters, capatablity of parts (as they're mostly stock), and if you want the frist one can be pulled from a junk yard.
But one serious down fall to a water conversion using a newer engine, the rebuild will be expensive. In the case of the rotary you'll pay a good 800 bucks on "okay" apex seals, and be looking at 450 bucks for a rotor housing (though these are not replaced on every build; apex seals should be). But you don't have to think as much, don't worry so much about internals working together (cam durations, timing, lift, right piston size), but more so the externals, turbos, timers, bov's, fuel injection, and stuff easily accessable too.
You sort of leave one set of problems for another, question is which do you feel more confortable dealling with. And which are easier to fix, replacment water pumps, or rebuilt turbos are easier than new cams and cranks.
http://frost.bbboy.net/vwengineconversions
If you don't already know theres some good info there on most conversions. Frankly if I hadn't put the money and time into the type IV I'd be getting a 13b. Also before you spend money, find a few forums, not just VW ones. I vist the Rx7club.com nice forum there, with plenty of inteligent people. I think I saw Shad Laws there a while back too. That's why I got the Rx7 brakes, stated looking there for engine info, and fell in love with the stock 4 pot brakes that are on these cars.
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