Perceptual misinterpretation of a real object is known as:

Illusion refers to a false interpretation of a sensory stimulus. Illusion can occur in delirium, which might be visual, auditory, gustatory, tactile, kinesthetic or visceral. Illusions may also occur in hysteria, depression, and schizophrenia. Hallucination is a false perception that occurs in the waking state in the absence of a sensory stimulus. Hallucinations can be auditory, visual, olfactory or gustatory, tactile, or somatic. Hallucination can occur secondary to tumors of the olfactory or basal temporal regions, toxins, fever, cerebro-vascular disease, central degenerative disorders and schizophrenia. Ref: Nurcombe B., Ebe M.H. (2008). Chapter 4. The Psychiatric Interview.