In The Velvet Underground Companion: Four Decades of Commentary, Lou Reed is quoted as explaining: "'Sister Ray' was done as a joke - no, not as a joke, but it has eight characters in it and this guy gets killed and nobody does anything. The situation is a bunch of drag queens taking some sailors home with them, shooting up on smack and having this orgy when the police appear."
Speaking of the guy who gets killed, you did hear the part in the third verse where the sailor gets shot and the only reaction is "Aw, you shouldn't do that; Don't you know you'll stain the carpet," didn't you? Just checking. This is Reed's sense of black humor, together with his storytelling skill honed during his early attempt at a writing career.
Also, pay attention to these lyrics and then meditate on this quote: "Andy shows movies and we f--k dogs on stage." - Lou Reed, 2003, in Steven Watson's Factory Made: Warhol and the Sixties. Does your mother know you listen to this stuff?