RINNAI Heater 1001FT Gas heater; was wondering if water required?

It shouldn't give an odor at all unless it hasn't been run a lot or cleaned. Rinnai recommends blowing compressed air through the front grates once a year. The pan is to catch condensate from the venting system. Hot flue gases contain moisture, which is a byproduct of burning propane. When this hits anything below 212 degrees, it will condensate and collect in the pan. The heat from the unit evaporates the water, thus making it a good system of condensate disposal. However, additional water can be added daily if you have problems with dryness in the air. The only other thing that can cause a bad odor is a compromised heat exchanger. You should have it checked, and if you don't already, have a CO detector in the room