Anything that can contribute to lag is preferred to be done out of the city - the problem is that the amount of space a player keeps loaded while being in an area is quite large, so that means that while players are in the city, most of the city is kept loaded at the same time. So that's a lot of "stuff" happening in a smallish space. Which all contributes to lag.
Waterfalls and things on their own aren't so much of a problem individually - but it's while there are a lot of machines and animals and water and things all contributing to lag - it gets too much for the server to handle.
The reason we've said no water in quarries is because people typically put water in the ground level of a quarry (so that if the quarry found lava it converts it to obsidian) because it's easier, meaning that it's then pouring down from ground level to bedrock. The more the water flows, the more lag increases. So that's why we've said no water in quarries.