The vanilla makes a big difference in the odors of my mouse colony. I use the artificial vanilla. Like Rich, I mix it up in a bigger container, but I'm pretty sure I use less than him. I add just enough to make noticeable color in the water, maybe roughly 1 teaspoon per gallon?
I'm not sure if it works by making them drink more, or if something is going on that changes how much ammonia is in their urine, or if enough vanilla passes through unprocessed that it just masks the odors, but whatever is happening, it definitely works!
Using it to cover up the taste of any medication in their water is also a good idea. For it to work best, they probably need to be used to the vanilla in the water in the first place, because any change in taste could make them drink less at first while they get used to it.
In the past, I have read about how some people who show horses will start adding gatorade or any number of similar things to their horses water a week or so before leaving for a show. I think at first it was added thinking the electrolytes in the gatorade might help the horse's performance, but people realized it was useful just so that the water at the showgrounds didn't taste so strange and cause the horse to not drink enough. The same theory should work for getting mice or rats to drink medicated water.