After Mike defeats The Tall Man with the help of his brother Jody, he wakes up in his bed to realize that, apparently, everything was a dream. Reggie is alive and, after listening to Mike's story, he tells him that Jody died in a car wreck two weeks before, The Tall Man does not exist and he just had a nightmare. They both decide then to hit the road and change of scenery for a while, and Mike goes upstair to pack the luggage. But The Tall Man is in his bedroom, waiting for him. As soon as Mike sees him in the reflexion of his closet's mirror and turns around, the hands of a dwarf break the glass and pull him through it.
The sudden appearance of The Tall Man at the very end of the movie instantly rules out the "everything was a dream" theory. At the same time, Jody's death and Reggie being safe and sound force us to disregard the "everything was real" theory too.
As confusing as it is, the only logical explanation of what happened is that the whole movie was neither a dream, not real, but a complex mix of both. That is, some parts were obviously a fantasy, a dream (i.e. Reggie's murder by The Lady in Lavender) while others actually happened and were strictly for real (i.e. the existence of The Tall Man). Nevertheless, it is never clearly stated what is a dream and what is not, so we have to draw our own conclusions in relation to many other elements of the story.
Of course, this explanation would be valid if we take Phantasm as a stand-alone film.
Nevertheless, if we take the sequels into account, we discover in Phantasm II that Mike is still asleep and dreaming during the ending of the previous installment. The Tall Man's apparition in his closet mirror, the fight between Reggie and the dwarves to rescue him and the blowing of the house are all part of the same nightmare. After this, Mike is interned in the Morningside Psychiatric Clinic for 7 years, receiving treatment for what his doctor considers to be just a figment of his imagination. After being released, he insists in believing that everything was real while even Reggie claims it was just a paranoid delusion. Later on, Reggie´s house is blown up by The Tall Man in a very similar way as in Mike's dream, finally coming true in an ominous way.