My Apple Watch only shows 5 GB of storage space total it’s supposed to have 8GB why would that be ????

Unpair your Apple Watch via the Watch app on your iPhone.

Then Re-pair your Apple Watch,this deletes temporary and corrupted files

and also clears the system cache freeing up a surprisingly large amount of storage space.And without any loss of data.

What update is it that's giving you the warning?

Because the watch operating system uses a fair bit of storage and some storage is held back for updates etc,just like an iphone.