While I'm not trying to argue for the upgrade right now, I don't think this is quite right.
If the Dream World was made of physical things, then Doremy wouldn't have been so shocked to see beings with physical forms travelling through it. In fact, a major story beat of Violet Detector is about the other dream dwellers being jealous that dream Sumireko currently has a "flesh and blood body."
And while it's true that characters with physical forms can be harmed by dream dwellers and Doremy, this is done mostly through danmaku, which is usually powered by spellcards using magic, spirit, etc.
Not only that, but this is a verse with a crap ton of examples where characters are capable of Non-Physical Interaction. In other words, it doesn't exactly seem farfetched that dream dwellers can interact and harm physical beings, and vice versa.
As a little bit of side evidence, Reimu being touched by a Dream Soul didn't send her physical body to the dream world. It was left behind when she traveled there. This further cements that physical things and beings don't normally belong there.
Honestly, whether or not my argument helps with the Mental Layer stuff doesn't matter to me right now. I think my dumb brain just fixated on one thing, haha.
Anyway, given what I've said above, it just seems blatantly wrong to say the Dream World is physical, when nearly everything points towards the opposite.